Video:How to Calculate Return on Equity

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Transcript:How to Calculate Return on Equity

Return on equity reveals how much profit a company earned in comparison to the total amount of shareholder equity found on the balance sheet. Shareholder equity is a creation of accounting that represents the assets created by the retained earnings of the business and the paid-in capital of the owners.

Why Return on Equity Reveals a Company's Earned Profit

A business that has a high return on equity is more likely to be one that is capable of generating cash internally. For the most part, the higher a company's return on equity compared to its industry, the better. If you owned a business that had a net worth (shareholder's equity) of $100 million dollars and it made $5 million in profit, it would be earning 5% on your equity ($5 ÷ $100 = .05, or 5%). The higher you can get the "return" on your equity, in this case 5%, the better.

Calculate Return On Equity by Dividing Profit By Shareholder Equity

Return on equity can be calculated by dividing net pofit by the average shareholder equity for the period. Net profit/average shareholder equity for period = Return on equity.

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