What is ROE and how is the formula calculated?

After knowing what it is ROI, you should be familiar with ROE or return of equity. Usually this ROE is used to show investors how efficient the business we are in is.

Apart from ROE, there is also what is referred to as ROA namely return of assets. Maybe you are still confused what is the difference between ROE and ROA? Then, what is ROE (return of equality)?

Come on, see the following explanation!

What is Return of Equity?

ROE or return of equity is type return company that reflects the performance of the company you are running. However, different types return otherwise, ROE will contain data on the acquisition of net profit with a predetermined capital.

In economics, return of equity is a measure to compare a company's net income to the total amount of investors' capital. 

Meanwhile, in terms of shares, ROE has a definition as the amount of net business income per incoming investor funds.

Quoted from Investopedia, ROE is also referred to as return on net assets because shareholder equity with company assets minus debt. In addition, ROE is also considered as a measure of a company's profitability and how efficient it is in generating profits.

The definition of ROE according to experts

Hery (2015: 230) 

ROE is the ratio used to measure a company's success in generating profits for shareholders. ROE is considered as a representation of shareholder wealth or company value. 

Cashmere (2014:202) 

Return On Equity is a comparison between net income and capital (core capital) of the company. This ratio shows the percentage level that ROE can generate is very important for shareholders and potential investors, because a high ROE means that an increase in ROE will cause an increase in shares. 

Fahmi (2012:99) 

Argued that "The ratio of net profit after tax to own capital is used to measure the rate of return on the investment of shareholders".

Ryan (2016: 113)

To measure the rate of return on equity, security analysts and shareholders generally pay close attention to this ratio, the higher the ROE generated by a company, the higher its stock price.

The use of ROE in business

This ROE has many benefits or uses, especially for investors, what are the uses ROE? Here's the summary!

1. As a measure of company profitability

Before making an investment, usually investors will see how high the company's profit is. So with that return of equity, Visa investors see and make decisions related to stock investment more easily.

2. Describe the company annually

A company that has a stable ROE and continues to grow is an ideal company. This can also be one of the points for investors to look at the company's business profile in the future, whether it can continue to grow and continue to generate profits or will it decline. 

3. As a basis for measuring business profits in the future

ROE is also often used as a benchmark to predict future business prospects. Maybe you are wondering what percentage is good ROE for stocks or good ROE? So, if your company has a minimum ROE of 1.0 or more, then it can be predicted that the next ROE level will likely increase and if the ROE results are close to 0, it means that the company cannot manage capital efficiently to generate income.

Then what is the ROE standard according to Bank Indonesia? According to BI standards, return of equity the good thing is that it can reach 12%.

4. The company's main factor in managing assets

The last use of ROE is as a benchmark for companies in managing capital, as mentioned above if the ROE value is below 0 or minus ROE, it means that the company is unable to generate profits as expected, even if it has received investment from investors.

The difference between ROE and ROA

As you know before, ROE is used as a benchmark for companies in managing capital into income. This is of course different from ROA or return of assets.

ROA is a metric that is measured by the value of a company's assets. So indirectly, ROA is used to measure how efficient a company is in managing assets to be able to generate profit or profits in the form of a percentage.

Factors affecting ROE

Not only capital can affect the value of ROE, there are several factors that influence it, namely:

Net profit

Net profit is also often used as the basis for measuring ROE, usually the elements that have a relationship with the measurement of profit are income or expenses.

Equity

Equity is often found in balance sheet financial statements which is the amount of capital a person's ownership rights over company assets. The types of equity that are often encountered are capital received, shares, dividends, and retained earnings.

Debt

Debt also has an influence on the value of ROE, because the higher the company's debt, the smaller the ROE generated.

Liquidity ratio

The final factor that affects ROE is liquidity in the form of receivables provided by the company to other parties, if this liquidity is not current it can also cause the ROE value to have a negative effect.

The formula for calculating ROE

To calculate ROE you can use the formula as follows:

ROE formula = Net Income: Capital 

Or you can use a formula like the following,

ROE formula = (Oven - Cost) : Capital

Examples of ROE questions and their solutions

In 2020, PT. ABC earns a net income of IDR 300 million, and has a personal capital of IDR 450 million. Then the ROE of PT. ABC is?

ROE formula  

= IDR 300 million : IDR 450 million

= 0,75

This means that the ROE of PT. ABC is 0,75, and this figure is still relatively small because it is still below number 1 and PT.ABC has not been able to make a return on investment in that year.

That's the definition and how to calculate ROE (return of equity) that you must know, especially if you are also a business actor.