ROE – Return on Equity Ratio and Formula How to Calculate It

ROE – Return on Equity ratio indicates percentage of Net Income earned compared to shareholders’ equity. This ration reveals how much profit the business earned with the money invested by shareholders. The following ROE – Return on Equity formula to be used to calculate this ratio:

ROE – Return on Equity= Net Income / Shareholders’ Equity

Net Income (check Income Statement Example to understand where to get this figure) should exclude dividends paid on common stock, but should include preferred stock dividends.

Following this approach in ROE formula Equity should exclude preferred shares. This is done to the fact that Net Income cannot be distributed to preferred shareholders, as they usually receive certain determined dividends and do not have a right to remaining profit distribution.

In the same as with other financial analysis ratios, the ratio itself is not sufficiently indicative. It should be compared to the same ratio of the company for previous periods and to industry level.

Also in case there were changes in Equity over the period in question (this can be seen from Balance Sheet, check this Sample Balance Sheet for understanding), it is recommended to take average Equity for the period, i.e. calculate simple average between equity value at the beginning and end of the particular period. This is logical to implement, since the formula uses Net Income, which is the amount generated rather over the period, but not at the end of period.

This Return on Equity Ratio is useful as it allows investors to judge how the manager of the business are able to utilize invested capital and earn profit. Also check other ratios for financial analysis:  Return on Assets – ROA Formula, Gross Profit Margin Ratio.

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