Formula to Calculate Return on Equity (ROE)
Return on Equity formula (ROE) is a measure of financial performance which is calculated as the net income divided by the shareholders equity, shareholders equity is calculated as the total companies assets minus the debt and this ratio can be considered as the return on net assets and signifies the efficiency in which the company is using assets to make profit.
Let’s say that they have invested in a company. Now they will look at the net income of the company for the year and also the shareholders’ equity of the year. Finally, they will compare the two to come up with a ratio. We will call it to return on equity (ROE).
Here’s the formula of return on equity ratio –
Example of ROE Formula
Let’s take a simple example to illustrate this concept.
Grandeur Co. has the following information –
- Net Income for the year 2017 – $120,000
- Shareholders’ Equity – $600,000
Find out the Return on Equity.
By using the formula, we get –
- Return on Equity = Net Income / Shareholders’ Equity
- Or = $120,000 / $600,000 = 20%.
The ratio should also be compared with the ROE of similar companies of the same industry to make a sense of whether the ROE of Grandeur Co. is higher or lower.
Nestle’s ROE Calculation
Let’s calculate ROE of Nestle from the financials provider below –
The consolidated income statement for the year ended 31st December 2014 & 2015
Consolidated balance sheet as at 31st December 2014 & 2015
- ROE = Net Income / Equity
- Return on Equity (2015) = 9467 / 63986 = 14.8%
- Return on Equity (2014) = 14904 / 71,884 = 20.7%
ROE of Nestle has decreased in 2015 (14.8%) as compared to 2014 (20.7%).
Colgate’s ROE Calculation
Below is a snapshot of the Colgate Ratio Analysis Excel Sheet. You may download this sheet from Ratio Analysis Excel Tutorial.
In this calculation of ROE, we have used Average Equity in the denominator.
In many years, Colgate’s ratio was in the range of 90%.
However, it shot up in 2014 to 126.45% and in 2015 to 327.2%.
Even though the Net income has reduced by 34%, ROE increased during these years because of share buyback and also accumulated losses further lowering the Shareholder’s equity denominator.
Explanation of ROE Formula
As you can see there are two components of this formula.
The first component is net income.
If you look at the income statement of a company, you would be able to find the net income as the last item. In the case of public companies, you may see that the net income is the second last item. In a few countries, it’s mandatory for public companies to show forth earnings per share (EPS) after they calculate the net income for the year.
The second component is the shareholders’ equity.
Here’s a snapshot of how it looks like –
|Additional Paid-up Capital:|
|(-) Treasury Shares||(**)|
|(-) Translation Reserve||(**)|
Once we know the two components, all we need to do is to use the formula to find out the ROE.
Return on equity is not only the formula of profit; rather it’s a formula of efficiency. By looking at the ratio, we get to know how efficient a company is.
- If the formula results in a higher ratio, it means that the shareholders’ equity has been rightly utilized to produce higher returns.
- On the other hand, if the ratio is lower, it means the efficiency of the company is utilizing its equity is also lower and as a result, the return is also lower.
The higher the ratio better would be the efficiency of the company. Thus, every investor should look at a company that has a higher ROE. However, they also need to look at other financial ratios to get a holistic view of how a company has been operating.
You can use the following ROE Calculator.
|Return on Equity (ROE) Formula =||
Return on Equity Formula in Excel (with Excel Template)
Let us now do the same example above in Excel. This is very simple. You need to provide the two inputs of Net Income and Shareholders’ Equity.
You can easily calculate ROE using the template provided.
Video on Return on Equity ROE Formula
This has been a guide to Return on Equity Formula. Here we discuss step by step how to calculate ROE along with practical examples and downloadable excel templates. You may also have a look at these articles below to learn more about Financial Analysis