Question

What can we say about the limitations involved in the assessment of ROE for analyzing the profitability of a company?Please give an understandable explanation

Answer 1

Answer:

ROE means return on equity. It is the most important financial ratio and profitability matrix. ROE that is used to analyze a company's ability to increase. ROE is valuation that is commonly used in order to the value of a company.

ROE is a profitability metric, comparing the profit to shareholder's to the capital provided or owned by shareholders. ROE is the amount of net income returned as a percentage of shareholder's equity. This ratio show a company's generate profits from its operation.

Limitation of ROE:

• Ignore cash flow : Business or company face many hurdles, when just getting started. For the profitability company, it should be challenge to make sure that more money is coming in every month than is going out. Focus on ROE, management should not focus on cash flow which is the most important one. ROE use only the net income which is not collect from the customers.
• Write down : A write down is used by many companies for its valuing assets. When written down fall, the company is going to reduce the value of an assets. It is reduce the shareholder's equity without changing net income.
• Debt : It is not consideration the amount of debt of a company with return on equity. It should be considered net income and shareholders equity. So that, company have an amounts of debt and like it is handling things to the return on equity.
• Use past financial data : Financial statements, management try to financial information to get better result for net income.
• Play around with equity : In the return on equity, increase ROE, there are two things to do, First is to handle the net income and find a way to decrease equity and other, handle the equity and find to way to increase net income. Here, net income increase is not the operational performance, It is increase by the accounting technique.

At last i can say that higher ROE is good, but higher ROE is not necessary to better financial performance of the company. The higher ROE should be the result of high financial leverage, but too high financial leverage is dangerous for a company's solvency.