The return on equity is its use when the organization fully covers its costs and makes a profit. The profitability indicator allows you to assess the efficiency of capital use. This relative ratio is less influenced by inflation than absolute indicators, since it is expressed in the ratio of profits and advanced funds.
Instructions
Step 1
A generalizing indicator expressing the efficiency of using the entire capital of an enterprise is the profitability of total capital investment. This indicator is determined by the formula:
RK = (R + P) x 100% / K, where
Р - costs associated with attracting borrowed sources, P is the profit remaining at the disposal of the enterprise, K - the amount of total capital used by the enterprise (balance sheet currency).
Step 2
When analyzing the return on equity, the return on invested and equity capital is calculated. Return on invested capital is defined as the ratio of the organization's net operating profit, net of taxes, to the average annual cost of invested capital.
Step 3
Invested capital refers to the capital invested in the core business of the firm. In other words, it is the sum of current assets in operating activities, net fixed assets and other assets. Under another method of calculation, the invested funds mean the amount of equity and long-term liabilities of the organization.
Step 4
The main thing that should be taken into account when calculating the invested capital is that only the amount of capital that goes to making a profit should be included in the calculation. Sometimes the calculation is carried out for the entire activity of the enterprise, without highlighting the main one. The margin of error in this case will depend on what the firm's operating profit will be and what the size of investments in non-core activities will be. In this regard, the return on invested capital can be found as follows: (operating profit x (1- tax rate)) / (long-term loans + equity) x 100%.
Step 5
Another indicator used in analyzing the efficiency of capital use is the return on equity. It shows how much profit the owners of the company receive for each unit of invested costs. Return on equity is calculated as the ratio of a firm's net profit to its equity. In this case, equity capital refers to the share of the company's ownership that shareholders can claim.
