Equity shareholders are the real owners of a company. They bear all the risk, whereas preference shareholders have priority of payments of dividends and as well as capital. The rate of dividend on equity shares differs from year to year depending upon the amount of profit. A company's performance is judged based on the amount of return on equity capital. To calculate return on equity capital, use the following formula: Return on equity capital = (Net profit after tax - Preference dividend) / Equity share capital Calculate the return on equity capital using the following information: ROE = (Net profit after tax - Preference dividend) x 100 / Equity share capital paid up ROE = 170,000 (Net profit after tax - Preference dividend) x 100 / 800,000 = 21.25% Comment: This ratio is useful for equity shareholders who want to know how profitable the company is, thereby determining the size of the dividend they will receive. The shortcut for calculating EPS is to divide profit after tax and the preference dividend by the number of shares. Continuing with the details from the first example: EPS = 170,000 (Net profit after tax - Preference dividend) x 100 / Number of equity shares = 170,000 / 10,000 = $17 per share These ratios are also known as turnover ratios because they indicate the speed at which assets are converted into sales. These ratios are calculated on sales. Inventory turn over ratio = Cost of sales / Average Stock Opening Stock = (Opening Stock + Closing stock) / 2 Consider the following information: Opening stock = $20,000 Closing stock = $10,000 Purchases = 50,000 Carriage on purchases = 5,000 Sale = $1,00,000 Required: Calculate the stock turnover ratio (STR), which is equal to the cost of goods sold divided by the average stock. Cost of goods sold = Opening stock + Purchase + Carriage - Closing stock = 2,00,000 + 50,000 + 5,000 - 10,000 = 65,000 Average stock = (Opening stock + closing stock) / 2 = (20,000 + 10,000) / 2 = $15,000 Therefore, the stock turnover ratio is 65,000 / 15,000 = 13:3 Comment: This ratio shows how many times a company's stock has been purchased in the course of the year.Return on Equity Capital: Explanation
Formula For Return on Equity Capital
Example
10,000 shares of $100 each, $80 paid
800,000
12% 5,000 preference shares of 50 each
250,000
Profit before tax
400,000
Rate of tax
50%
Solution
Profit
400,000
Less tax 50%
200,000
Profit after tax
200,000
Less preference dividend 12% (250,000)
30,000
170,000
Earnings Per Share (EPS)
Example
Current Assets Movement or Efficiency Activity Ratio
Example
Solution
Explain Return on Equity Capital With Examples FAQs
Return on equity capital is a profitability ratio that measures a company's ability to generate income with the money shareholders have invested. It is calculated by dividing net income by average equity capital. The higher the return, the more efficient the company is at using its shareholders' money to generate profits.
The formula for calculating the return on equity capital is given below:Return on equity capital = (Net profit after tax - Preference dividend) x 100 / share capital
The shortcut for calculating the current assets movement or efficiency activity ratio is to divide cost of goods sold by the average stock. Cost of goods sold = Opening stock + Purchase + Carriage - Closing stockAverage Stock = (Opening stock + Closing stock) / 2
Inventory turn over ratio = Cost of sales / Average Stock Opening Stock = (Opening Stock + Closing stock) / 2
EPS is used to find out the profit earned by a company on each share held by the shareholders.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
To learn more about True, visit his personal website or view his author profiles on Amazon, Nasdaq and Forbes.
