Return on equity ratio is a profitability ratio. It is invaluable performance indictor for the investor. Investors base their decision over this ratio while making any decision. It is actually an indicator regarding the management’s efficiency of generating earnings from the money invested by the investors. It is denoted by ROE.
Formula
It is calculated by dividing the annual net income after interest and taxes by the average shareholder’s equity.
ROE = Earning after interest and taxes / Average Shareholder’s equity
Example
PD industries has earned a profit after interest and taxes amount to $500,000. Shareholder’s equity figure on 1st Jan and 31 Dec 2015 are as 1,200,000 and 1,400,000 respectively. Calculate ROE.
Solution
Average Shareholder’s equity = (1,200,000 + 1,400,000) / 2 = $1,300,000
ROE = Earning after interest and taxes / Average Shareholder’s equity = 500,000 / 1,300,000 = 38 {1bb28fb76c3d282be6cfd0391ccf1d9529baae691cd895e2d45215811b51644c}