Return on equity is the ratio of a company's profit to its equity. The return on equity shows how interest has been paid on a company's equity within an accounting period.
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Definition / explanation
The return on equity is an economic key figure that can be used to calculate how high the return on equity was during a period.
The return on equity expresses the earning power of a company and equity providers can use it to get an impression of whether the investment has paid off for a company.
How is the return on equity calculated?
The formula for calculating the return on equity is:
Return on Equity = Profit / Equity
Return on equity = EBIT / equity
example - For example, if the profit is 60,000 euros and the equity is 800,000 euros, the return on equity is 7.5 %
In general, a high return on equity is a positive sign of a thriving business. However, depending on the industry in which a company operates, the return on equity can fluctuate widely.
Target values for return on equity
Grundsätzlich gilt, egal in welcher Branche das Unternehmen tätig ist, dass die Eigenkapitalrentabilität mindestens so hoch ausfallen sollte, wie der durchschnittliche Zinssatz auf dem Capital market. Denn andernfalls macht es wenig Sinn, das Eigenkapital im Unternehmen einzusetzen.
Problems and disadvantages
With the return on equity, different sizes of the annual financial statements are related to each other. If different accounting standards are used by companies in their annual financial statements, the resulting equity values can differ greatly from one another. That makes it difficult to compare the different results.
The leverage effect is understood as the influence on the return on equity through borrowing. In this way, the profit can be increased, although the equity remains the same.