Profitability is a fairly broad concept that can be applied to various components of any company. She can pick up synonyms such as efficiency, payback or profitability. It can be applied in relation to assets, capital, production, sales, etc. When calculating any of the performance indicators, the answer to the same questions is given: “are resources used correctly” and “are there any benefits”. The return on equity also speaks of the same (the formula used to calculate it is presented below).
Equity and investors
Under own capital refers to the financial assets of the owner of the company, shareholders and investors. The last group is represented by people or companies investing in business development, in third-party firms. It is important for them to know that their investments are profitable. The further cooperation and development of the company in the market depends on this.
Every company is important financial injections - both internal and external. And the situation is much more favorable when these funds are not represented by bank loans, but by investments of sponsors or owners.
How to understand whether it is worth continuing to invest in a company? Very simple. It is only necessary to calculate the return on equity ratio. The formula is easy to use and transparent. It can be used for any organization, based on the data of the balance sheet.
Indicator calculation
What does the formula look like? Return on equity is calculated by the following calculation:
Rsk = state of emergency / SK, where:
- Rsk - return on equity.
- SK - equity of the company.
- PE - the net profit of the enterprise.
Return on equity 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 enterprise and the profitability of equity.
Do not forget that in any company not only own funds can be invested , but also borrowed ones. In this case, the return on equity, the calculation formula of which is given above, gives an objective assessment of the profit from each unit of cash invested by investors.
If necessary, the profitability formula can be changed to obtain a percentage result. In this case, it is enough to multiply the obtained quotient by 100.
If you need to calculate the indicator for another period (for example, less than a year), then you need a different formula. Return on equity in such cases is calculated as follows:
Rsk = PE * (365 / Period in days) / ((SKNp + SKKp) / 2), where
SKNP and SKKP - equity at the beginning and end of the period, respectively.
Everything is relative
So that investors or owners can fully evaluate the profitability of their investments, it is necessary to compare it with the same indicator that could be obtained by financing another 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 investment.
A formula developed for calculating a normative value can also be used. The return on equity in this case is calculated using the average rate on bank deposits for the period (Sd) and income tax (SNP):
Krnk = Sd * (1-Snp).
When comparing the two indicators, it will immediately become clear how well the company is doing. But for the full picture, it is necessary to conduct an analysis of the effectiveness of equity over several 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, replacing equipment with more modern ones), then it is quite natural that some decrease in profit. But in this case, profitability will certainly return to its previous level - and, possibly, will become higher - in the shortest possible time.
About norms
Each indicator has its own norm, including the effectiveness of equity. If you focus on developed countries (for example, such as England and the USA), then the profitability should be in the range of 10-12%. For developing countries whose economies are prone to inflation, this percentage should be much higher.
You need to know that you should not always rely on the return on equity, the formula for which is presented first. The value may turn out to be overestimated, 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 a Dupont equation. It allows you to more accurately calculate the profitability and the influence of some factors on it.
Eventually
Each owner and investor should be aware of the considered formula. Return on equity is a good helper in any area of activity. It is the calculations that will tell you when and where to invest your funds, as well as a good time to withdraw them. This is very important information in the world of investment.
Owners and managers, this indicator gives a clear picture of the direction of activity. The results can tell you exactly how to continue to conduct business: along the same path or change it dramatically. And the adoption of such decisions will provide increased profits and greater stability in the market.