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                                                      Return on equity

Return on equity is one of the most important profitability ratio. this ratio reveals that how efficiently company is managing their financial resources. the stakeholder or investors would get more return while increase of ROE as well as a lowering ROE that indicator of that company is using its financial assets for unproductive ways. 

ROE formula 

First thing, we need to get clarification of balance sheet elements. generally, Balance sheet categorized as three parts such as Equity, Assets, and Liability. equity is stakeholder's paid in capital and resource money. 

Assets are sort out as Tangible and intangible assets . 

Liability, company has to be paid to suppliers and lenders.

Asset - Liability = equity

The Equity is calculated by paid-in capital + Retaining  money.

ROE = Net profit / Equity 

The company provide dividend certain percentage of money from net income. after paid off the dividend the remaining balance  will be added back in to shareholders equity- Equity  is also called as net worth. 

How to measure ROE

A higher ROE means that company is efficiently utilizing their equity finance. but, the investors should analyze further that company's financial leverage. if a company extremely  used its the financial leverage through debt that might  make more financial  risk  in future.

A lower ROE means that company is unable to generate adequate profit from equity financing. some reason could make low ROE, that could be such are wrong investment decisions, bad management team, and failure projects.

Generally, A high ROE considered as a good indicator for long-term investment however, scaling of ROE would vary from sectors to sector. service sectors typically having ROE than manufacturing sectors. so, we need to combine with other key Ratio that those of ROA, Equity/ debt Ratio, and Equity multiplier.

Not all ROE's are same, some industries may provide well return to investors, in other hand, other sector might give low return to investors. so that, investors should compare ROE with competitors of the same industry. increasing of ROE means that company is executing the solid financial decisions. in conversely, decreasing of ROE indicates that company is taking wrong financial decision.  

Advantage and Disadvantage of R

 if company has more debt that the ROE shows even great figure. however, ROE will only be calculated by equity return. perhaps, the company if occur any business risk follow that the investors risk will increase dramatically.

A company tend to reduce its debt burden that will cause, decreasing its ROE. because, specific amount of the money might go for debt repayment. in the short run, ROE could fall but in the long-term perspective which action will give more benefits to company and shareholders.

ROA and ROE   

ROE shows how efficiently management handling their financial resource as well as ROA reveal how a company utilizing their assets and which of those assets are being  transferred to productive operation.  if company shows low ROA and high ROE that the company is making worst financial decision.