Flow of the Article:
- Return on Equity Formula
- ROE Calculator
- ROE Template
Return on Equity Formula
This is one of the most common finance formulas shareholders use to find out the return on their investment.
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 return on equity (ROE).
Here’s the formula of return on equity ratio –
Explanation of ROE Formula
As you can see there are two components of this formula.
The first component is the 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 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 return on equity.
Use of Return on Equity Formula
Return on equity is not only a 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 in 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 higher ROE. However, they also need to look at other financial ratios to get a holistic view of how a company has been operating.
Example of ROE Formula
Let’s take a simple example to illustrate return on equity formula.
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 of return on equity, 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 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 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 the 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 Shareholders equity denominator.
Return on Equity Calculator
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 the real rate of return in the template provided.
You can download this ROE template here – Return on Equity Excel Template
This has been a guide to Return on Equity Formula, practical examples, and ROE calculator along with excel templates download. You may also have a look at these articles below to learn more about Financial Analysis
- Retention Ratio Formula
- Dividend Payout Ratio
- ROE vs Dupont ROE
- Return on Capital Employed Examples
The post Return on Equity (ROE) Formula | Calculator (with Excel Template) appeared first on Learn Investment Banking: Financial Modeling Training Courses Online.