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In: Finance

Without exception, return on equity (ROE) is regarded are the most important measurements of a company's...

Without exception, return on equity (ROE) is regarded are the most important measurements of a company's success, regardless of the industry of the company. Define ROE, and explain why this measurement is regarded in such high esteem in the financial world of financial statement analysis. Second, other than ROA, what financial ratio would you consider as the next most important for analyzing success of a company's performance?

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Expert Solution

Return on Equity

Return on equity measures profitability by revealing how much income it generated with the shareholders’ money.

Formula for calculating return on equity:

Return on equity= Net income/Shareholders Equity

Importance of Return on Equity:

  1. It reveals how efficiently a company has used shareholders money. When a company has a low ROE, it indicates that the company could not successfully use shareholders equity and the company cannot provide substantial returns to the shareholder.
  2. ROE impacts share valuations and measures the intrinsic value of a company.
  3. It helps to compare the profitability of a company with its peers.

Other financial ratios used for measuring a company’s success:

  1. Return on Capital Employed (ROCE): It indicated the overall profitability of a company for equity and debt investors and measures the efficiency with which both sources of capital are employed. It is calculated as Earnings before Interest and Tax (EBIT) divided by capital employed. It is used for analyzing companies with higher debt. Whereas, ROE is used to measure companies with low debt and is the ratio to be analyzed after ROE.
  2. Price to Earnings ratio (P/E): P/E ration indicates how much investors are investing for every dollar of earnings. It is calculated as market price per share divided by earnings per share.
  3. Debt to Equity ratio: It indicates how much debt the company is using to finance its operations in relation to equity. It is calculated as total liabilities divided by shareholders equity.
  4. Current Ratio: It is a liquidity ratio and measures the ability of a company to pay its short-term obligations. It is calculated as current assets divided by current liabilities.

I hope that was helpful :)


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