Question

1. Explain the difference between the ROE and ROR for a public company.

2. Using this, show how it is possible, from a starting point, for one to go up and the other to go down.

Answer 1

ROE is Return on Equity

ROR is Return on Revenue

• They are different as ROE is the ratio of Profit to Equity, whereas ROR is the ratio of Profit to Revenue.
• ROE measures the returns of only the sharegolders (of the public company), whereas ROR measures the returns of both the sharegolders and the debt holders (of the public company).

It is posible for one to go up and the other to go down if the operating expenses have changed over time. Let's look at the following example to clear this concept:

Assuming Equity in first year to be $150,000 and in second year to be $200,000 and debt to be $100,000 (10% interest payable) in both the years

	Year 1	Year 2
Revenue	$100,000	$80,000
Operating Expenses + Depreciation	$30,000	$10,000
EBIT	$70,000	$70,000
Interest	$10,000	$10,000
EBT	$60,000	$60,000
Taxes	$6,000	$6,000
PAT (Net Profit)	$54,000	$54,000

For Year 1:

• ROE = $54,000/$150,000 = 36%
• ROR = $54,000/$100,000 = 54%

For Year 2:

• ROE = $54,000/$200,000 = 27% {Decrease}
• ROR = $54,000/$80,000 = 67.5% {Increase}

Thus, it can easily be observed that it is posible for one to go up and the other to go down.