The Return on Equity (ROE) expresses the degree of remuneration of shareholders for their capital invested into the company. This ratio expresses the measurement of the return on the investment of the members (resources that over time they have made or left – not withdrawing profits – in the company, that is, of the net worth.

ROE = NET INCOME / EQUITY'S BOOK VALUE 

The ROE is therefore an indicator of global profitability, let's say of the overall profitability obtained by the company, summary of all the management areas (operational, financial, ancillary, tax) that have contributed to the operating result; an indicator, in short, of the degree of risk remuneration faced by the entrepreneur or the partners.

This static approach of analysis determines a value that is given by the ratio of net operating income (net profit) to net worth indicating the profitability of the own assets used by the property for the operation of the business. However, it is inevitable that ROE will be at least higher than the return on risk-free investments (such as government bonds) for a potential investor to see their participation as positive. This indicator values in percentage terms the degree of remuneration in favour of shareholders for the capital invested by the company in the company.

However, it must always be considered that for ROE, there are no optimal values in fact for this purpose it is always useful to compare with a benchmark analysis with other realities. Moreover, it cannot ignore the reference sector as it must be sufficient to reward both the general risk of carrying out the business as well as the specific risk associated with the characteristics of the reference sector.

If there are significant changes in equity from one year to the next (revaluation reserves, increased share capital, conferments for future capital increases), it may be misleading to use the ROE indicator statically and therefore as a single indicator of the administrative period, so it is possible to obtain a dynamic ROE that uses an average value to the denominator between the beginning of the year and the end of the financial year. This is because in order to ascertain the profitability of the company's equity (own assets or equity) it is more correct to average the initial value with the final value of the equity.

 

FINANCIAL LEVERAGE

The ROE is used in the analysis of financial leverage as it helps to understand what the optimal policy of composition of funding sources (financing capital) has been able to meet the financing requirements generated by the employment structure. Especially in understanding the multiplier effect that is underlying the structure of the enterprise.

In this regard, it is very important to understand the debt ratio that is generally identified in the ratio (Debt to Equity) understood as the ratio of total third-party assets to equity and that it is included in the following formula:

ROE = ROI + (ROI - i) * D/E

 

 

 

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