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Calculating return on equity and return on assets

From: Excel 2007: Financial Analysis

Video: Calculating return on equity and return on assets

In this lesson, I'll discuss how to calculate return on equity and return on assets, two important ratios when you're considering the financial health of a company. A publicly traded company has one goal: to maximize a shareholder value. The bottom line measure of a firm shareholder value is its equity, which is Total Assets minus Total Liabilities. Comparing the relationship between a company's earnings to its equity provides a clear picture of the company's ability to generate returns for its stockholders. You divide the company's net income, which is its income after taxes by its shareholder's equity.

Calculating return on equity and return on assets

In this lesson, I'll discuss how to calculate return on equity and return on assets, two important ratios when you're considering the financial health of a company. A publicly traded company has one goal: to maximize a shareholder value. The bottom line measure of a firm shareholder value is its equity, which is Total Assets minus Total Liabilities. Comparing the relationship between a company's earnings to its equity provides a clear picture of the company's ability to generate returns for its stockholders. You divide the company's net income, which is its income after taxes by its shareholder's equity.

So here in the worksheet, I have two entries, one is the Net Income After Taxes and the other is the Shareholder's Equity. So to divide the two, type equal to start the formula and we have Net Income After Taxes in cell B5, divide that by Shareholder's Equity in B6 and press Enter and there you have your ratio of 0.11 for the return on equity. You can compare this result to other companies in which you're considering investing, so you can determine which company has provided a better result for its shareholders. And just as a general basis for comparison, most firms in the S&P 500 generate ROE ratios of between 10% and 15%.

You should also take into consideration a firm's Return on Assets. Companies need to make sure that their infrastructure, which includes their office buildings, computers and manufacturing systems, are of high enough quality to support the company's activities. It's important that companies not spend too much on their assets, as doing so cuts into profitability, but they should spend enough to ensure their infrastructure supports the operations. One measure you can use to determine how efficiently a company spends its money on assets is by calculating the Return on Assets ratio. To calculate the Return on Assets ratio, you divide a company's earnings before interest and taxes by the company's total assets.

So here we have those two values, the Earnings Before Income and Taxes and the Total Assets. So I'll divide earnings, B5/B6 and you have a ratio of 0.04. Comparing a company's Return on Assets ratio to those of other firms in the sector help you determine how efficiently the company employs its assets. Reductions in a company's Return on Assets ratio could indicate either economic opalescence, such as when a company's manufacturing system falls behind the technology curve or it could mean that the company just invested a significant amount of money in the new system and has yet to reap the benefits of the new technology.

As always, be sure to read a company's public filings to help you interpret the numbers included in those documents. You should compare a company's Return on Equity and Return on Assets ratios to determine how the company pays for its operations. When a company's Return on Equity is higher than its Return on Assets, it's usually an indication that the company finances its operations through sales of stock instead of taking on debt. If Return on Assets is higher than Return on Equity, then the opposite is true.

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Excel 2007: Financial Analysis

51 video lessons · 13628 viewers

Curt Frye
Author

 
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  1. 2m 6s
    1. Welcome
      1m 8s
    2. Using the exercise files
      32s
    3. Disclaimer
      26s
  2. 13m 20s
    1. Separating inputs and formulas
      2m 2s
    2. Avoiding common mistakes
      5m 39s
    3. Tracing formula precedents and dependents
      2m 52s
    4. Evaluating Excel formulas step by step
      2m 47s
  3. 18m 40s
    1. Tracking income and expenses using an Excel table
      3m 29s
    2. Creating a Pivot Table from table data
      3m 36s
    3. Pivoting a Pivot Table
      2m 22s
    4. Filtering a Pivot Table
      3m 11s
    5. Adding Pivot Table columns to enhance data analysis
      3m 5s
    6. Tracking cash flow using a Pivot Chart
      2m 57s
  4. 18m 48s
    1. Reading a corporate financial statement
      6m 1s
    2. Introducing common-sizing strategies for analyzing financial statements
      3m 59s
    3. Creating common-sized income statements
      3m 1s
    4. Creating common-sized balance sheets
      2m 53s
    5. Calculating percentage changes in financial statements
      2m 54s
  5. 8m 12s
    1. Calculating earnings per share
      1m 54s
    2. Calculating return on equity and return on assets
      2m 50s
    3. Calculating gross profit margin and net profit margin
      3m 28s
  6. 6m 19s
    1. Calculating the current ratio and quick ratio
      2m 47s
    2. Calculating the average collection period
      1m 56s
    3. Calculating inventory turnover
      1m 36s
  7. 6m 12s
    1. Calculating the equity ratio
      1m 26s
    2. Calculating the debt ratio
      2m 57s
    3. Calculating the times interest earned ratio
      1m 49s
  8. 10m 58s
    1. Calculating simple interest and compound interest
      3m 36s
    2. Applying nominal versus effective interest rates (APR versus APY)
      3m 21s
    3. Calculating the number of days between events
      4m 1s
  9. 13m 32s
    1. Computing the future value of an investment
      3m 30s
    2. Calculating present value
      2m 29s
    3. Calculating net present value
      2m 42s
    4. Calculating internal rate of return
      2m 24s
    5. Calculating NPV and IRR for uneven input periods (XNPV and XIRR)
      2m 27s
  10. 7m 30s
    1. Projecting future results using the Forecast function
      2m 9s
    2. Performing quick forecasts using the Fill handle
      2m 57s
    3. Adding a trendline to a chart
      2m 24s
  11. 22m 28s
    1. Introducing amortization
      2m 20s
    2. Calculating payments on a fully amortized loan
      2m 21s
    3. Calculating payments on a partially amortized loan (balloon payments)
      2m 4s
    4. Calculating interest and principal components of loan repayments
      5m 32s
    5. Introducing depreciation
      2m 1s
    6. Calculating straight line depreciation
      1m 30s
    7. Calculating declining balance depreciation
      3m 24s
    8. Calculating double declining balance depreciation
      3m 16s
  12. 9m 34s
    1. Introducing bonds and bond terminology
      1m 37s
    2. Calculating a bond's yield
      2m 15s
    3. Calculating the value of zero coupon bonds
      3m 18s
    4. Pricing bonds to be offered to investors
      2m 24s
  13. 23s
    1. Goodbye
      23s

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