Return on Equity is

$$Return\quad on\quad Equity=\frac { Net\quad Profit }{ Total\quad Equity } $$

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**a type of Profitability Ratio**that determines the**Return on Total Shareholder’s Fund in a Company.**It is a measure of how good a company is using the Assets to create profit.**.**__Return on Equity is also known as Return on Net Worth__$$Return\quad on\quad Equity=\frac { Net\quad Profit }{ Total\quad Equity } $$

**Net Profit = Profit after Excluding all Expenses and Tax = Net Sales – (Cost of Goods Sold + Operating Expenses + Depreciation /Amortization + Interest Expenses + Tax paid)Where,**- And
**Total Equity = Total Shareholder’s Fund = Equity Share Capital + Reserves and Surplus + Preferred Equity** __Return on Equity (ROE) multiplied by 100 provides the ROE in percentage terms.__

## Return on Common Equity

**Return on Common Equity = (Net Profit – Preferred Dividends) / Common Equity**

**Where,****Preferred Dividend = Dividend Paid on Preferred Equity****And Common Equity = Equity Share Capital + Reserves and Surplus**

__If the Company is having no Preferred Equity, then the Return on Common Equity is the same as Return on Equity.____Preferred Equity shares that are issued on a preference basis and have a Fixed Rate of Dividend.__## Significance and Interpretation

- Return on Equity is an important fact from a shareholder’s point of view,
**a high ROE attracts an investor and a low ROE is not considered good for investing.** - Considering only the Net profit figure may be an incomplete analysis as Net Profit Ratio does not consider the total funds available, hence ROE is a better measure to judge the profitability of a company.
**High ROE**can be obtained either due to**increased Net profit (Big Numerator) or reduced Total Equity (Small Denominator)**, the former i.e.**Increased Net profit is good and favourable for investors**but the former i.e.**Reduced Total Equity is considered to be a risk for the company.**__It must be noted that comparing the performance of two companies based on ROE is useful only if both companies belong to the same sector of the industry.__

### Examples

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**Example 1: **

**Given below are few details of M/S XYZ Ltd., use them an calculate the Return on Equity and Return on Common equity for M/S XYZ Ltd. The rate of tax on profit is 30%.**Particulars | Amount (in Rs.) |
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Equity Share Capital | 5000000.00 |

Reserves and Surplus | 1000000.00 |

Preferred Equity @10% return | 500000.00 |

EBIT (Earnings Before Interest and Taxes) | 4000000.00 |

Interest Expenses | 1000000.00 |

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**Solution:**

**Total Equity =**Equity Share Capital + Reserves and Surplus + Preferred Equity**⇨**Rs. 6500000**PBT (Profit Before Tax) =**EBIT – Interest Expenses**⇨**Rs. 3000000.00

**Net Profit =**PBT – Tax

**⇨**3000000 – 30% of 3000000

**⇨**Rs. 2100000.00

**Return on Equity =**Net Profit / Total Equity

**⇨**2100000 / 6500000

**⇨**21/65

**Hence, Return on Equity (ROE) = 21/65 or 0.3230 or 32.30%**

**Preferred Dividend =**10% of Preferred Equity

**⇨**10% of 500000

**⇨**Rs. 50000.00

**Common Equity =**Equity and Share Capital + Reserves and Surplus

**⇨**Rs. 6000000.00

**Return on Common Equity =**(Net Profit – Preferred Dividend) / Common Equity

**⇨**(2100000 – 50000) / 6000000

**⇨**2050000 / 6000000

**⇨**41/120

**Hence, Return on Common Equity = 41/120 or 0.3417 or 34.17%**