Return on Equity
Return on equity (ROE) is a financial measure that provides investors with insight into a company’s profitability in relation to stockholder equity. It shows how a company is managing the money shareholders have contributed, with a higher ROE demonstrating good management and a healthy income and growth from equity financing.
Return on equity is a valuable metric when comparing a company to competitors in its industry, highlighting which businesses are operating with the greatest financial efficiency and offering the best potential for investors.
Key takeaways from this section:
- Return on equity (ROE) is a financial measure that shows how efficiently a company is managing it shareholder investments.
- Calculate ROE by dividing a business’s net income by shareholder equity.
- ROE can be assessed by comparing to industry and peer averages.
- It is better to have an ROE that is the average, or slightly higher than the average of your business’ peers. A too high ROE can be an indication of risk.
Understanding return on equity
Return on equity can be very informative for potential investors, but it relies on knowing other factors such as industry averages. Knowing if an ROE is good or not relies on this context, so a healthy ROE can be identified by comparing a business with the average for its peers.
In general, the higher the number for ROE the better, and a low or negative ROE can indicate problems. It’s also worth remembering that an unusually high ROE can also indicate issues such as a sudden windfall after consistently low profits, or an excess of debt.
How to calculate return on equity
The formula for return on equity is net income divided by shareholder equity. Net income represents a company’s bottom line profits reported on the income statement, before stock dividends are paid out. You could also use free cash flow (FCF) instead of net income to assess profitability.
To work out shareholder equity, a company’s liabilities must be subtracted from its assets, showing what is left over for dividends should a company settle all its liabilities.
Return on equity can be used to estimate a company’s growth rates, and predicting how stock will grow and produce potential dividends. To get a clear picture of your company’s potential for growth, you’ll need to multiply the established ROE with your retention ratio – another metric which measures how much of your business’ revenue can be set aside for growth.
ROE can be an industry-specific metric to measure, meaning that the nature of its value will depend on competing stocks within the industry. To clarify – different industries have different expectations of their ROE, so this must be taken into account when using ROE as a metric for performance and growth potential.
You’ll want to aim for your ROE to hit just above the average for the rest of your industry, this gives a manageable target that can be built on as your investments grow. If you’re getting a high ROE, this can indicate to both you and your peers that your equity account is small against your net income – which can be a sign of an unstable and risk-leaden financial situation.
Return on Equity FAQs
What is a good ROE?
It is hard to pinpoint what a good ROE is because often good ROE levels are dependent on their sector. Generally, it’s best to research what the ROE is for competitors in your industry, and to use the averages to target your ROE plans. Aim for the average or just higher than average for the best results.
What does a high ROE mean for investors?
An ROE that is slightly higher than average can show that those in charge of a business have a good grasp on the investment context needed for strong growth. It could indicate a better approach to driving profits and consequently, it could mean better results for shareholders.
What is the difference between ROI and ROE?
Both ROI – return on investment – and ROE – return on equity – can be invaluable tools for seeing how well a business is performing financially. Businesses use these metrics to forecast and plan for growth.
There are significant differences however. ROI indicates the profitability of an investment, showing the potential returns an investor can get from their investment against the investment’s cost. To establish ROI, you need to divide the investment’s profit by the amount of the cost.
ROE in contrast, is a metric that shows the how profitable a business is because of its equity. It demonstrates the return on assets owned by the business minus any debts or liabilities that the business has. It is industry specific and shows how good the business is at turning its equity into profits.
Have you thought about Invoice Finance as a cash flow solution for your business?
Invoice finance allows you to release cash quickly from your unpaid invoices.
As your lender, we can release up to 90% of your invoices within 24 hours. On payment of the invoice from your customers, we will then release the final amount minus any fees and charges. There are different types of invoice financing options available to businesses depending on the situation and the level of control they require in collecting unpaid invoices.
We are an invoice financing company who offer a solution whereby payments are collected on your behalf managed by our team of expert credit controllers so you can focus on running your business. Our Confidential Invoice Discounting solution is offered to businesses who want to maintain their own credit control processes, therefore this remains strictly confidential so your customers are unaware of our involvement.
The benefits of invoice finance companies such as Novuna Business cash flow
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We explore ways you can begin improving your cash flow situation and start getting your business on track to positive cash flow.
Competent staff, slick technology. Would recommend
Halo is one of the smartest bits of tech I have seen & every team is only as good a it's people and I would like to take this time to actually specifically point out Alex Hall & Claire Davies. Alex is an account manager that has continually improved during our time working together and is a real credit to Novuna. Claire has been exceptional from start to finish; meticulous in her work and very patient with us at every temp - an absolute star. It is a shame that the email address went to a generic platform and not each individual. I totally understand why this works better for companies but it did mean that the personal element was lost meaning that starts like Claire will be harder to identify from a customer point of view.
High recommedation for Novuna Business Cashflow.
My company was in need of invoice factoring to assist with the cashflow due to the nature of debtor days with our clients. After looking at a number of options, the right decision was made to work in partnership with Novuna Business Cashflow. Right from setup through sales to customer service, the communication and support has been outstanding. Providing me with all the information I needed regarding new clients coming onto our books. The system they use is so user friendly and the drawdown payments are very efficient in the fast moving world of temporary payroll. This has allowed my company to look at positive growth knowing we are safe financial hands. I would highly recommend Novuna Business Cashflow 10/10.
Set up went well and communication was good.
Syed and Vipul were extremely helpful top class service
Very helpful from the start
Great people made this process very straightforward.
Jemma from Novuna (formally Hitachi) was brilliant. Worked with us throughout the process and succeeded when some others had failed. Carried out the necessary checks with a smile and cheery demeanour, making what would have been a laborious process quite manageable.
Teething problems -Maybe ?
It's still early days so I may alter this review at a later date. However with retentions and concentration limits and other items, were finding were not getting 85% up front, were probably getting nearer 70% Also when a customer pays the remaining allegedly 15% due to us seems not to be credited to become available. For instance a customer paid Â£6918 and a customer paid Â£1300 hence we should see an extra Â£1330 available (15% of both these payments). However availability seemed to go down and not up by Â£1330 !!! Hard to work out where this 15% has actually gone ? I'll re-submit this review when things become clearer.
I found Hitachi true to their world in every aspect of the service they promised. I can't recommend enough.
Excellent Customer care and service.
Excellent customer service from start of initial conversations, right through to finally becoming a customer. The whole team involved are a credit to Hitachi, they were accommodating and informative the whole way along the process. I would highly recommend Hitachi to future clients and business associates. Thanks Alan.
I really enjoyed working with the Hitachi team, professional, helpful and really good people to deal with. They have made what could have been a very difficult experience a pleasure. Very happy to recommend them.
Hitachi made the process of moving factoring facilities painless, bearing in mind we previously had our facility with the same provider since 1997. I cant fault Hitachi's staff and processes and we are delighted with the move.
Staff excellent all together professional
Great service so far
From start to finish the process for transferring our invoice finance to Hitachi has been been brilliant, a smooth transition, great communication our link Person Jonathan Oakes has helped the process go through seamlessly, A great experience so far and a brilliant start to what we hope will be a long term partnership.