A company uses many ratios and percentages to attain profit and loss and other factors that give information about the business. They are essential for the decision-making of an enterprise, both external and internal sources.
Two of those terms are Return on Equity and Return on Net Worth. They are used in place of each other but have some distinctions between them.
- Return on Equity (ROE) measures a company’s profitability by comparing its net income to its shareholder’s equity. At the same time, Return on Net Worth (RONW) calculates profitability by dividing net income by total net worth.
- ROE is a more widely used metric in financial analysis, while RONW is primarily used in personal finance.
- ROE is a more accurate measure of a company’s ability to generate profits for its shareholders, while RONW is more focused on an individual’s net worth.
Return on Equity vs Return on Net Worth
Return on Net Worth can be put on anything like loans, debentures, etc. While if we are talking about return on equity, the calculation has to be on the company’s equity only.
It is primarily a measure of the return generated by the company’s net assets.
Return on Net Worth also indicates a company’s profitability over its Net Worth, also known as the firm’s capital. A Net Worth or Capital represents the total value of the company.
Net Worth includes shareholders’ Equity, Reserves, preference share capital, securities, etc.
|Parameters of Comparison||Return on Equity||Return on Net Worth|
|Definition||Used to measure the profitability of the business about Equity.||They are used to calculate the profit percentage from the company’s net income and net worth.|
|Usage||It is mainly used to compare the performance of companies related to the same field.||It indicates the creditworthiness of the company.|
|Advantage||Help in planning for future investment.||Gets the right amount of Net Worth and tells whether the company is doing well.|
|Disadvantage||The ratio can be manipulated.||The ratio is made from the investors’ perspective, not the company’s.|
|Formula another name||N/A||Return on Capital|
What is Return on Equity?
Return on Equity, or RoE, is a company’s earnings or profits with the invested money from the equity shareholders. Equity shareholders are the people who are the owners of the company.
ThereThe shares can be divided into three categories: standard, preferred and retained.
Following is the way to calculate Return on Equity:
- Take the net income of the business (annual).
- Get the shareholder’s Equity.
- Divide the net income by shareholders’ Equity.
Since Equity is assets minus the company’s liabilities, Return on Equity can also be considered another way to calculate the ratio.
A common way to calculate ROE is by DuPont Formula as well because using this formula makes it easier to understand the changes over a long period. It has three components:
- Net Profit Margin: Net Profit (revenue- cost) divided by revenue.
- Assets turnover: Net sales revenue divided by Average total assets.
- Accounting leverage: Total assets divided by the total assets minus total liabilities.
15 to 20 per cent of Return on Equity is considered a good percentage.
What is Return on Net Worth?
Return on Net Worth is a ratio used to calculate the rate of a company’s profitability percentage. It calculates the percentage of return that the company is getting over some time.
The formula for RoNW comes out by dividing the Net Income by Net Worth. It is calculated at the end of a fiscal year generally. Net Worth includes shareholders’ equity, reserves, and preference share capital.
A Higher Ratio of RoNW indicates that a company is efficiently utilising the shareholders’ money efficiently. If the return is negative, the company will not be able to raise funds from the market, which is a significant loss for any business.
To get out of this situation, the firm should pay out all its debt and decrease the use of any expensive extra expenses that they are making.
Main Differences Between Return on Equity and Return on Net Worth
- Return on Equity is different as it is made only on the money that the company’s equity shareholders invest. Return on Net worth can be on anything a company has, meaning loans, debentures, or securities.
- Return on Net Worth has more features as it comprises more company materials, like debentures and securities, while Return on Equity is only used to calculate the shareholders’ equity.
- Return on Net Worth is more extensive than Return on Equity as it has more sources of money and debt than Return on Equity.
- Investors or shareholders are more interested in Return on Equity as it is their return on money. Return on Net Worth is more beneficial for the management of the company.
- Return on Equity is used to compare the type of companies in a field to see which are doing better or worse in different areas. Return on Net Worth is not used for this purpose.
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Chara Yadav holds MBA in Finance. Her goal is to simplify finance-related topics. She has worked in finance for about 25 years. She has held multiple finance and banking classes for business schools and communities. Read more at her bio page.