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Return on Equity Ratio (ROE Formula, Examples) | Calculate Return on Equity - YouTube
Channel: WallStreetMojo
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welcome today we shall go through the
article on return on equity and that is
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ROE ROE vs. DuPont are we on the
Wallstreetmojo platform so let's
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understand what is the concept of ROE
ROE that is the return on equity is a
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measurement of profitability
profitability of a project or an entity
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of a particular period and ratio of
profitability over equity that is the
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amount invested by the owners and the
shareholders next is what is the utility
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of an roe roe he shows the measure the
and the nature of success of the
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business during the period it measures
the corporations or the entity's
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profitability by revealing how much
profit a company generates within the
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money shareholders have invested
basically it indicates the amount of
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profit available for shareholders after
all deductions this is a ratio of profit
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over the amount invested by shareholders
and next to let's looking to the
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calculations of roe the ROE
calculations are generally on the two
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types the general method that of
calculation of ROE is it's the net
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income generated by the entity or the
organization divided by the average
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shareholders equity so what is about the
average shareholders equity its it is
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arrived at averaging the opening and the
closing shareholders equity we shall
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understand the details in next tab once
we go through the numbers and then there
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is a detailed method which is known as
DuPont method of ROE and the DuPont a
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method of roe generally is a little
expansive manner the calculations are
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generally in an expansive manner it's
like the net income over net sell
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multiplied by net sales divided by the
total assets and total assets divided by
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the total equity so it's basically a
profit margin
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multiplied by total asset turnover
multiplied by equity multiplier so this
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is a basically a combination of 3
different ratios and this method is used
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to find out the exact reason for the
change of our ROE from one period to
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another now let's understand the general
calculation of return on equity first of
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all this side will see the small
demonstrative profit and loss statement
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and we'll construct a small balance
sheet and go on to calculate the return
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on equity so here let's do some profit
and loss statement try to construct or
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profit and loss statement and balance
sheet so let's do it for 2 years
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that is year 1 and here it is year 2
and so let me take it over there in
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balance sheet as well
balance sheet here there is a small
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mistake let me correct this one and so
here is year 1 and now let me do other
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heads in the profit and loss and balance
sheet so let me start with sales and
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other income so then we have the total
income and now next is the expenses
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related head so here we have see suppose
the material for to run an organization
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or do some production and then labour and
then so we have the other expenses and
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total expenses over here now let put it
the gross profit gross profit that is
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this so we have the profit after tax and
dividend our for preferred shares and
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then the we arrive at the net income of
the period
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so now let's populate the numbers over
here for example sales let's
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number a 865 let's put it as 865 and
then next year it goes on thing increase
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at a 950 and then over here let's put at
90 and 100 and total that comes to is
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so this is over here that is the total
income so we have the total expenses we
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have populated the expenses over here so
it's put it at one line below to match
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okay so we have the total income as 955
for year 1 and total expenses as 715
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now let populate the
other figures that is gross profit over
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year so this so let's do it over here
and so now we have the profit before
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taxes 180 and 183 and let's have the tax
figures see it is this is over here and
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let's go on to the profit after tax so
we have calculated the profit after tax
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and dividend on preferred shares and so
put in a figure like constant figure for
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both the years and we have arrived at
net income as say 155 - and 157 for
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respectively year 1 and year 2
now let's quickly construct the balance
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sheet and then we can arrive at the
return on equity figure to understand
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how it is calculated so we have
populated like the heads as fixstick
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assets current assets then we have the
total assets that is fixed as has the
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current assets and the liabilities 1 and
then we have the total liability and net
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assets which C is equal to total as a -
total liabilities which is the net
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assets now we will populate the figures
over here so we have populated the
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figure fixed assets a 1 2 5 0 and it
moving on to 1 3 2 5 for second year
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and then the total assets coming us and
we have the current assets as 450 and
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510 so these are the figures and we
arrive at the with the long term
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durability and current liability figures
over here we arrive at the net assets as
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1 2 7 5 and 1 3 6 so the next is the
preference capital so we put in a figure
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of preference capital and then we move
on to have the shareholders equity
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divided into reserves and capital so
let's now populate the figures for this
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preference capital shareholders equity
reserves equity
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so we arrive at the shareholders equity
as 990 divided
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into reserves reserves an equity capital
equity capital is constant for both the
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years reserves is increasing on year on
year 250 and 340 so let's have a
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shareholders capital and previous year
as will put in a figure over here to
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arrive at the average equity capital
required for calculation on return on
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equity next we have now the profit and
loss and the balance sheet over here
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let's highlight both the cases and over
here and now let's go on to calculate
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the return on equity which we are
understanding in today so we let's come
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from now we have the return on equity
over here let's calculate the return on
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equity the formula is equal to net
income divided by average formula this
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formula close so we have 17 point and
now let's convert it into percentage
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terms so we have 18 percent over here
and if we click and drag it over here so
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we have the next year so this is 18
percent and 17 percent over here let's
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highlight over there to understand to
understand this so mmm when the border
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over here so now we have calculated the
return on equity in the normal way that
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is a net income divided by the
shareholder T average capital for each
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of the period year 1 and here 2 so now
we will look into the return on equity
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for the dupont method so which is
detailed method of understanding the
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return on equity so here let's have the
different ratios ratio over here say we
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have the profit margin profit margin
then we have total asset turnover
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turnover ratio and then equity
multiplier so here and finally the roe
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return on equity so ROE basically
it's ready put it over use with that so
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so let's have it for say for me remember
all this ratios for firm A and firm B
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basically this is an illustration
whereby will see the same roe for both
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the firms but there are variations in
the underlying different ratios which
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shows how the businesses running in both
the cases so here let's have the profit
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on profit margin that is the total
profit divided by the sales so here's a
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B let's have it as 40% over here and the
C we have 20% over here and then the
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total asset turnover let's it let it be
point 3 over here and see 5 over
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here so which shows high turnover equity
multiplier that is the number of times
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the capital it is getting multiplied for
running the business and over here 5
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and say point zero 6 over here so roe
is basically as we have understood in
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the beginning so let's do it over here
centralize and so are we as we have
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understood it's basically in the dupont
method it is the multiplication of all
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the above 3 ratios so let's do it
over here so point 4 that is 40
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percent is point 4 in to is point
3 that is the total asset turnover
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and then finally the so this is 6 and
over here it's say 20 percent is 20
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divided by 100 which comes to as .2 to know
multiplied by the total asset turnover
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which is 5 and
so x equity x which is point 6 so
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basically in both the cases we are
seeing the seen a seen return on
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equity but the breakup of the different
ratios which is consisting of the roe
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has different numbers so if we
understand what it is so let's try to
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understand how this implies about the
business so for firm A and firm B let's
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try to segregate and understand the
figures so the firm A the profit margin
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is high the profit margin margin is high
basically these are the observations
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over here so we can see the profit
margin is high and the financial
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leverage is also quite good that is that
that is at 5 that is equity multiplier
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the financial leverage and whereas asset
turnover is low that is the far which is
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at point 3 spot 3 and the firm
is not able to utilize that asset better
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now moving on to firm B how the figures
understand the breakup of the figures
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for e of the firm so the firm B the
profit margin is lower which is a 20%
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whereas the financial leverages is very
poor that is at spot 6 whereas the
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total asset turnover that is the number
of times the assets are getting turnover
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during the period to run the businesses
5 which is on the higher side this for
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high high asset turnover the firm has
done well and arrived at the high return
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on equity figure so in both the cases
whether in different ways the numbers
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are different but the end result that is
roe is same in both the cases so the
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conclusion over here in this study is in
the dupoint method of return on equity
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is the dupoint highlights this
calculation highlights underlying
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figures resulting in a roe particular way so
even if the roe is seen
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it will
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highlight the different ways the lying
ratios about how the business is running
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and how the firm is performing during a
particular period
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