Return on Equity

Return on Equity (ROE) Ratio – Definition, Explanation and Use:

Return on equity ratio (ROE) is one of the most widely used financial ratio. This ratio shows the rate of return, owners are earning on their investment made within the business. It measures efficiency of a business in generating profits from every dollar of owner’s funds.

ROE Formula for Companies:

return on equity 1

ROE Formula for Sole Proprietors:

return on capital 2

It is obviously better for a business to maintain or increase the return on equity, but the figure should also be compared with rates of interest. If the return achieved by a business is higher than the rates paid by banks etc., then the business is a worthwhile investment. Similar to return on asset ratio, this ratio greatly varies from industry to industry. Shoestring companies like law or tax consultants enjoy high return on equity as they do not require many assets. On the other hand capital intensive industries require large infrastructure builds before they start operations like airlines so usually they do not have high ROE.