{"id":4136,"date":"2020-10-26T16:14:31","date_gmt":"2020-10-26T16:14:31","guid":{"rendered":"https:\/\/courses.lumenlearning.com\/wm-financialaccounting\/?post_type=chapter&#038;p=4136"},"modified":"2020-11-15T20:59:53","modified_gmt":"2020-11-15T20:59:53","slug":"return-on-equity","status":"publish","type":"chapter","link":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/chapter\/return-on-equity\/","title":{"raw":"Return on Equity","rendered":"Return on Equity"},"content":{"raw":"<div class=\"textbox learning-objectives\">\r\n<h3>Learning Outcomes<\/h3>\r\n<ul>\r\n \t<li style=\"font-weight: 400;\">Calculate the rate of return on shareholder's equity<\/li>\r\n<\/ul>\r\n<\/div>\r\nReturn on equity (ROE) measures financial performance by dividing net income by shareholders' equity. Because shareholders' equity is equal to a company\u2019s assets minus its debt, ROE is considered the return on net assets (as opposed to return on total assets).\r\n\r\nThe goal of investing in a corporation is for stockholders to accumulate wealth as a result of the company making a profit. The ratio looks at how well the investments of preferred and common stockholders are being used to reach that goal.\r\n\r\nThe following formula shows how to calculate ROE:\r\n\r\n[latex]\\dfrac{\\text{net income}}{\\text{average total stockholders' equity}}[\/latex]\r\n\r\nFor example:\u00a0[latex]\\dfrac{248,000}{\\frac{2,675,000+2,447,000}{2}}=9.7\\%[\/latex]\r\n<div class=\"table-wrapper\">\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Income Statement\r\nFor the Years Ended December 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<\/tr>\r\n<tr>\r\n<td>Income before income tax<\/td>\r\n<td class=\"r\">$314,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Income tax expense<\/td>\r\n<td class=\"r\">66,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td><strong>Net income<\/strong><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<table class=\"fin-table acctstatement\"><caption>Jonick Company\r\nComparative Balance Sheet\r\nDecember 31, 2019 and 2018<\/caption>\r\n<tbody>\r\n<tr>\r\n<th><\/th>\r\n<th scope=\"col\">2019<\/th>\r\n<th scope=\"col\">2018<\/th>\r\n<\/tr>\r\n<tr>\r\n<td colspan=\"3\"><span style=\"text-transform: uppercase;\"><strong>Stockholders' Equity<\/strong><\/span><\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Preferred $1.50 stock, $20 par<\/td>\r\n<td class=\"r\">$166,000<\/td>\r\n<td class=\"r\">$166,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Common stock, $10 par<\/td>\r\n<td class=\"r\">83,000<\/td>\r\n<td class=\"r\">83,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td>Retained earnings<\/td>\r\n<td class=\"r\">2,426,000<\/td>\r\n<td class=\"r\">2,198,000<\/td>\r\n<\/tr>\r\n<tr class=\"highlight\">\r\n<td>\u00a0 \u00a0 \u00a0 <strong>Total stockholders' equity<\/strong><\/td>\r\n<td class=\"r\">$2,675,000<\/td>\r\n<td class=\"r\">$2,447,000<\/td>\r\n<\/tr>\r\n<tr>\r\n<td><strong>Total liabilities and stockholders' equity<\/strong><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$3,950,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$3,606,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\r\n<\/tr>\r\n<\/tbody>\r\n<\/table>\r\n<\/div>\r\nIn our example, Jonick Company shows a ROE of 9.7%, which means the owners, who together have invested about $2.5 million, are seeing the company achieve in 2019 a return on that invested capital of almost 10%.\r\n\r\nROE ratios vary significantly from one industry group or sector to another. For instance, utility companies overall may have a lower ROE but be more stable and less risky, whereas tech firms overall may have a higher expected ROE but the individual stocks may be riskier and more volatile.\r\n\r\nInconsistent profits (e.g. a net loss one year, high profits the next) can skew ROE on an annual basis. The extent of leverage (debt financing) can also affect ROE. As with any measure, this one has to be applied thoughtfully and in conjunction with other metrics.\r\n\r\nCommon variations of this metric include Return on Common Stockholders Equity (which would treat preferred stock more like debt) and Return on Invested Capital (ROIC). The formula for ROIC is (net income - dividends) \/ (debt + equity).\r\n<div class=\"textbox tryit\">\r\n<h3>PRACTICE QUESTION<\/h3>\r\nhttps:\/\/assessments.lumenlearning.com\/assessments\/23863\r\n\r\n<\/div>","rendered":"<div class=\"textbox learning-objectives\">\n<h3>Learning Outcomes<\/h3>\n<ul>\n<li style=\"font-weight: 400;\">Calculate the rate of return on shareholder&#8217;s equity<\/li>\n<\/ul>\n<\/div>\n<p>Return on equity (ROE) measures financial performance by dividing net income by shareholders&#8217; equity. Because shareholders&#8217; equity is equal to a company\u2019s assets minus its debt, ROE is considered the return on net assets (as opposed to return on total assets).<\/p>\n<p>The goal of investing in a corporation is for stockholders to accumulate wealth as a result of the company making a profit. The ratio looks at how well the investments of preferred and common stockholders are being used to reach that goal.<\/p>\n<p>The following formula shows how to calculate ROE:<\/p>\n<p>[latex]\\dfrac{\\text{net income}}{\\text{average total stockholders' equity}}[\/latex]<\/p>\n<p>For example:\u00a0[latex]\\dfrac{248,000}{\\frac{2,675,000+2,447,000}{2}}=9.7\\%[\/latex]<\/p>\n<div class=\"table-wrapper\">\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Income Statement<br \/>\nFor the Years Ended December 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th class=\"u-sr-only\" scope=\"col\">Description<\/th>\n<th scope=\"col\">2019<\/th>\n<\/tr>\n<tr>\n<td>Income before income tax<\/td>\n<td class=\"r\">$314,000<\/td>\n<\/tr>\n<tr>\n<td>Income tax expense<\/td>\n<td class=\"r\">66,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td><strong>Net income<\/strong><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$248,000 <span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<table class=\"fin-table acctstatement\">\n<caption>Jonick Company<br \/>\nComparative Balance Sheet<br \/>\nDecember 31, 2019 and 2018<\/caption>\n<tbody>\n<tr>\n<th><\/th>\n<th scope=\"col\">2019<\/th>\n<th scope=\"col\">2018<\/th>\n<\/tr>\n<tr>\n<td colspan=\"3\"><span style=\"text-transform: uppercase;\"><strong>Stockholders&#8217; Equity<\/strong><\/span><\/td>\n<\/tr>\n<tr>\n<td>Preferred $1.50 stock, $20 par<\/td>\n<td class=\"r\">$166,000<\/td>\n<td class=\"r\">$166,000<\/td>\n<\/tr>\n<tr>\n<td>Common stock, $10 par<\/td>\n<td class=\"r\">83,000<\/td>\n<td class=\"r\">83,000<\/td>\n<\/tr>\n<tr>\n<td>Retained earnings<\/td>\n<td class=\"r\">2,426,000<\/td>\n<td class=\"r\">2,198,000<\/td>\n<\/tr>\n<tr class=\"highlight\">\n<td>\u00a0 \u00a0 \u00a0 <strong>Total stockholders&#8217; equity<\/strong><\/td>\n<td class=\"r\">$2,675,000<\/td>\n<td class=\"r\">$2,447,000<\/td>\n<\/tr>\n<tr>\n<td><strong>Total liabilities and stockholders&#8217; equity<\/strong><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$3,950,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\n<td class=\"r line-single line-double\"><span class=\"u-sr-only\">Single Line<\/span>$3,606,000<span class=\"u-sr-only\">Double Line<\/span><\/td>\n<\/tr>\n<\/tbody>\n<\/table>\n<\/div>\n<p>In our example, Jonick Company shows a ROE of 9.7%, which means the owners, who together have invested about $2.5 million, are seeing the company achieve in 2019 a return on that invested capital of almost 10%.<\/p>\n<p>ROE ratios vary significantly from one industry group or sector to another. For instance, utility companies overall may have a lower ROE but be more stable and less risky, whereas tech firms overall may have a higher expected ROE but the individual stocks may be riskier and more volatile.<\/p>\n<p>Inconsistent profits (e.g. a net loss one year, high profits the next) can skew ROE on an annual basis. The extent of leverage (debt financing) can also affect ROE. As with any measure, this one has to be applied thoughtfully and in conjunction with other metrics.<\/p>\n<p>Common variations of this metric include Return on Common Stockholders Equity (which would treat preferred stock more like debt) and Return on Invested Capital (ROIC). The formula for ROIC is (net income &#8211; dividends) \/ (debt + equity).<\/p>\n<div class=\"textbox tryit\">\n<h3>PRACTICE QUESTION<\/h3>\n<p>\t<iframe id=\"lumen_assessment_23863\" class=\"resizable\" src=\"https:\/\/assessments.lumenlearning.com\/assessments\/load?assessment_id=23863&#38;embed=1&#38;external_user_id=&#38;external_context_id=&#38;iframe_resize_id=lumen_assessment_23863\" frameborder=\"0\" style=\"border:none;width:100%;height:100%;min-height:400px;\"><br \/>\n\t<\/iframe><\/p>\n<\/div>\n\n\t\t\t <section class=\"citations-section\" role=\"contentinfo\">\n\t\t\t <h3>Candela Citations<\/h3>\n\t\t\t\t\t <div>\n\t\t\t\t\t\t <div id=\"citation-list-4136\">\n\t\t\t\t\t\t\t <div class=\"licensing\"><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Original<\/div><ul class=\"citation-list\"><li>Return on Equity. <strong>Authored by<\/strong>: Joseph Cooke. <strong>Provided by<\/strong>: Lumen Learning. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by\/4.0\/\">CC BY: Attribution<\/a><\/em><\/li><\/ul><div class=\"license-attribution-dropdown-subheading\">CC licensed content, Shared previously<\/div><ul class=\"citation-list\"><li>Principles of Financial Accounting. <strong>Authored by<\/strong>: Christine Jonick. <strong>Located at<\/strong>: <a target=\"_blank\" href=\"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615\">https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615<\/a>. <strong>License<\/strong>: <em><a target=\"_blank\" rel=\"license\" href=\"https:\/\/creativecommons.org\/licenses\/by-sa\/4.0\/\">CC BY-SA: Attribution-ShareAlike<\/a><\/em><\/li><\/ul><\/div>\n\t\t\t\t\t\t <\/div>\n\t\t\t\t\t <\/div>\n\t\t\t <\/section>","protected":false},"author":90270,"menu_order":16,"template":"","meta":{"_candela_citation":"[{\"type\":\"original\",\"description\":\"Return on Equity\",\"author\":\"Joseph Cooke\",\"organization\":\"Lumen Learning\",\"url\":\"\",\"project\":\"\",\"license\":\"cc-by\",\"license_terms\":\"\"},{\"type\":\"cc\",\"description\":\"Principles of Financial Accounting\",\"author\":\"Christine Jonick\",\"organization\":\"\",\"url\":\"https:\/\/web.ung.edu\/media\/university-press\/Principles-of-Financial-Accounting.pdf?t=1601063299615\",\"project\":\"\",\"license\":\"cc-by-sa\",\"license_terms\":\"\"}]","CANDELA_OUTCOMES_GUID":"","pb_show_title":"on","pb_short_title":"","pb_subtitle":"","pb_authors":[],"pb_section_license":""},"chapter-type":[],"contributor":[],"license":[],"class_list":["post-4136","chapter","type-chapter","status-publish","hentry"],"part":857,"_links":{"self":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4136","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters"}],"about":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/types\/chapter"}],"author":[{"embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/users\/90270"}],"version-history":[{"count":12,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4136\/revisions"}],"predecessor-version":[{"id":5785,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4136\/revisions\/5785"}],"part":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/parts\/857"}],"metadata":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapters\/4136\/metadata\/"}],"wp:attachment":[{"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/media?parent=4136"}],"wp:term":[{"taxonomy":"chapter-type","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/pressbooks\/v2\/chapter-type?post=4136"},{"taxonomy":"contributor","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/contributor?post=4136"},{"taxonomy":"license","embeddable":true,"href":"https:\/\/courses.lumenlearning.com\/suny-clinton-financialaccounting\/wp-json\/wp\/v2\/license?post=4136"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}