Understanding Business Accounting For Dummies - UK, 4th UK Edition
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The return on equity (ROE) ratio tells you how much profit a business earned in comparison to the book value of its owners’ equity. This ratio is especially useful for privately owned businesses, which have no easy way of determining the market value of owners’ equity.

ROE is also calculated for public corporations, but, just like book value per share, it generally plays a secondary role and is not the dominant factor driving market prices.

Here’s how you calculate the return on equity ratio:

Net income ÷ Owners’ equity = ROE

The business whose income statement and balance sheet are shown in the two figures below earned $32.47 million of net income for the year just ended and has $217.72 million of owners’ equity at the end of the year. Therefore, its return on equity (ROE) is 14.9 percent, as shown below:

$32,470,000 net income ÷ $217,720,000 owners’ equity = 14.9% ROE
An income statement example for a business.
An income statement example for a business.
A balance sheet example for a business.
A balance sheet example for a business.

Net income increases owners’ equity, so it makes sense to express net income as the percentage of improvement in the owners’ equity.

About This Article

This article is from the book:

About the book authors:

Colin Barrow was head of the Enterprise Group at Cranfield School of Management for ten years and is the best-selling author of Starting a Business For Dummies. He launched the Business Growth Program, the UK's most successful and longest-running training program for business managers. Since that time, Barrow has taught at business schools across the US and Europe. John A. Tracy, CPA, is professor of accounting, emeritus, at the University of Colorado in Boulder.

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