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