The desired formula: return on equity to help investors

Profitability is a fairly broad concept that can be applied to different components of any company. It can choose synonyms such as efficiency, payback or profitability. It can be applied to assets, capital, production, sales, etc. When calculating any of the performance indicators, the answer is to the same questions: "are resources being used correctly" and "is there any benefit." The profitability of own capital speaks the same thing (the formula used for its calculation is presented below).

Own capital and investors

Under own capital means financial assets of the owner of the company, shareholders and investors. The last group is represented by people or companies investing their money in the development of business, in third-party firms. It is important for them to know that their investments are profitable. On this depends the further cooperation and development of the company in the market.

To each firm financial injections are important - both internal, and external. And the situation is much more favorable when these funds are represented not by bank loans, but by investments of sponsors or owners.

How to understand whether it is worth continuing to invest finance in this or that company? Very simple. You just need to calculate the return on equity. The formula is easy to use and transparent. It can be used for any organization, based on the balance sheet data.

Calculation of

What does the formula look like? Return on equity is calculated by the following calculation:

Рск = ЧП / СК, where:

- Rsk - return on equity.

- SC - equity of the firm.

- PE - net profit of the enterprise.

Payback of own funds is calculated most often for the year. And all the necessary values are taken for the same period. The result gives a complete picture of the activities of the company and the profitability of equity.

Do not forget that any company can be invested not only its own funds, but also borrowed. In this case, the profitability of equity capital, the formula for calculating which is given above, gives an objective assessment of the profit from each unit of cash invested by investors.

If necessary, the formula for profitability can be changed to obtain the result in percent. In this case, multiply the received quotient by 100.

If it is necessary to calculate the indicator for another period (for example, less than a year), then another formula is needed. Return on equity in such cases is calculated as follows:

Рск = ЧП * (365 / Period in days) / ((СНнп + СКкп) / 2), where

SKnp and SKKp - equity at the beginning and end of the period, respectively.

Everything is relative

That investors or owners could estimate in full profitableness of the investments, it is necessary to compare it with a similar indicator which could be received at financing of other company. If the effectiveness of the proposed investment is higher than the real one, then it may be worth switching to other companies that require investments.

A formula developed for calculating the normative value can also be used. Return on equity in this case is calculated using the average rate for bank deposits for the period (SD) and for income tax (Cnp):

Kpn = Cd * (1-Cnn).

When you compare the two indicators, you will immediately see how well the company is doing. But for a full picture it is necessary to conduct analysis of the effectiveness of equity in a few years so that it is possible to more accurately determine the temporary or permanent decline in profitability.

It is also necessary to take into account the degree of development of the company. If at the end of the period some innovations were introduced (for example, the replacement of equipment with a more modern one), then it is quite natural that some decrease in profits occurs. But in this case, profitability will necessarily return to its previous level - and, perhaps, will be higher - in the shortest possible time.

About the norms

Each indicator has its own norm, including the effectiveness of its own capital. If you focus on developed countries (for example, such as England and the United States), then the profitability should be within 10-12%. For developing countries, whose economy is subject to inflation, this percentage should be much greater.

It is necessary to know that it is not always necessary to rely on the return on equity, the formula for calculating which is presented at the beginning. The value may turn out to be too high, since the indicator is subject to the influence of other financial levers. One of them is the amount of borrowed capital. For such cases, there is the Du Pont equation. It allows you to more accurately calculate the profitability and impact on it of certain factors.

Eventually

Each owner and investor should know the formula considered. Profitability of equity is a good assistant in any area of activity. It is calculations that will prompt when and where to invest their funds, as well as a good time for their withdrawal. This is very important information in the world of investment.

Owners and managers of this indicator gives a clear picture of the direction of activity. The results obtained may suggest how to continue doing business: on the same path or change it radically. And the adoption of such solutions will ensure an increase in profits and greater stability in the market.