Many business owners believe their companies are “profitable,” yet when asked to explain how effectively the capital they have invested is actually generating returns, the answers are often vague. This is precisely where ROE (Return on Equity) emerges as a critical metric.
ROE is not merely a financial figure. It is a measure of how efficiently owners’ capital is employed, as well as a vital indicator used by investors, banks, and management to assess the overall quality of a company’s performance.
This article explores how to calculate ROE, covering its fundamental concept, formula, calculation examples, healthy ROE benchmarks, and common pitfalls in ROE analysis.
What Is ROE (Return on Equity)?
Return on Equity (ROE) is a financial ratio that measures a company’s ability to generate net profit from shareholders’ equity.
In simple terms, ROE answers the following question:
For every Rp1 of owners’ capital, how much profit does the company generate?
The higher the ROE, the more efficiently owners’ capital is converted into profit. For this reason, ROE is closely monitored by:
- Business owners and board members
- Investors and shareholders
- Banks and financial institutions
- Financial analysts
Read also:
– Corporate profitability ratios
– Types of financial ratios
The ROE Formula Explained
Basic ROE Formula
In general, the ROE formula is:
ROE = Net Profit / Equity
Or expressed as a percentage:
ROE (%) = (Net Profit ÷ Equity) × 100%
Understanding the Components of ROE
To avoid miscalculation, it is essential to understand each component clearly:
1. Net Profit
- Taken from the income statement
- Uses profit after tax
- Not operating profit and not gross profit
2. Equity
- Taken from the balance sheet
- Consists of:
- Paid-in capital
- Retained earnings
- Does not include liabilities
The most common mistake in calculating ROE is using pre-tax profit or mixing equity with liabilities.
Read also:
– How to read corporate financial statements
How to Calculate ROE from Financial Statements
Simple ROE Calculation Example
Assume a company reports the following figures:
- Net profit for the year: Rp500,000,000
- Total equity: Rp2,500,000,000
Then:
ROE = 500,000,000 / 2,500,000,000 = 0.20
ROE = 20%
Meaning:
For every Rp1 of owners’ capital, the company generates Rp0.20 in profit annually.
This represents a generally healthy ROE, depending on the industry.
Step-by-Step ROE Calculation
A systematic approach:
- Extract net profit from the income statement
- Extract equity from the balance sheet
- Ensure both figures refer to the same period
- Calculate and convert the result into a percentage
What Is a Good ROE? (Benchmarks)
One of the most frequently asked questions is:
“What ROE level is considered healthy?”
General ROE Guidelines
As a rough benchmark:
- >15% → excellent
- 10–15% → reasonably healthy
- <10% → requires evaluation
- Negative ROE → warning signal
However, ROE should never be compared blindly across industries.
Industry-Based ROE Benchmarks
Indicative ranges by sector:
- Manufacturing: 10–18%
- Retail: 12–20%
- Services: often higher due to asset-light structures
- Trading: volatile, depending on margin and volume
Therefore, sound ROE analysis must always be paired with industry benchmarks.
Read also:
– Financial performance analysis
ROE Analysis: Do Not Judge by the Number Alone
A high ROE does not always indicate a healthy company.
High ROE Driven by Excessive Debt
ROE can surge when:
- Equity is minimal
- Debt levels are high
- Financial leverage is excessive
Mathematically, ROE may appear attractive, but financial risk increases significantly.
Example:
- Company A: ROE 25%, but extremely high DER
- Company B: ROE 15%, with a sound capital structure
Over the long term, Company B is often more stable.
Read also:
– Debt to Equity Ratio (DER)
What Does Negative ROE Mean?
Negative ROE typically results from:
- Negative net profit (losses)
- Negative equity due to accumulated losses
A negative ROE is a serious red flag, particularly for:
- Investors
- Banks
- Potential business partners
Read also:
– Analyzing distressed financial statements
Differences Between ROE, ROI, and ROA
Many people mistakenly use ROE interchangeably with ROI or ROA.
| Ratio | Primary Focus | Best Suited For |
|---|---|---|
| ROE | Owners’ equity | Investors, owners |
| ROI | Investment/project | Management |
| ROA | Total assets | Operations |
- ROE → equity efficiency
- ROA → asset efficiency
- ROI → effectiveness of specific investments
Read also:
– How to calculate ROI
– How to calculate ROA
Common Mistakes in ROE Calculation
To avoid misleading conclusions, steer clear of these errors:
- Using profit before tax
- Relying solely on ending equity without trend analysis
- Ignoring industry comparisons
- Overlooking debt structure
- Evaluating ROE based on a single year only
ROE must be analyzed as a time series, not as a one-year snapshot.
Is ROE Suitable for SMEs?
The answer is: it depends on the quality of bookkeeping.
ROE Is Suitable for SMEs If:
- Records are well maintained
- Business capital is separated from personal funds
- Financial statements are consistent
ROE Is Less Relevant If:
- Business and personal finances are mixed
- Net profit is not clearly recorded
Read also:
– Common financial mistakes in SMEs
– Proper bookkeeping for SMEs
How to Improve ROE in a Healthy Way
Improving ROE does not mean indiscriminately increasing debt. Sustainable strategies include:
- Enhancing profit margins
- Improving working capital efficiency
- Reducing unproductive assets
- Optimizing inventory and receivables
- Controlling operating expenses
A healthy ROE is the result of operational excellence, not financial engineering.
Conclusion
ROE is a key indicator for assessing the effectiveness of owners’ capital.
However, ROE should never be interpreted in isolation.
Robust ROE analysis is always complemented by:
- ROA
- DER
- Cash flow analysis
- Historical trends
For business owners, ROE answers one essential question:
Is the capital I have invested truly working at its full potential?
If the answer is no, ROE serves as a signal indicating where improvement should begin.
