Return on equity (ROE) simply means how much return you are generating over the shareholders’ funds.
Shareholders’ funds are called equity.
What is Equity?
The money a company receives after selling its ownership is called equity or shareholders’ funds.
Suppose you open a samosa shop in your local area. You raise ₹5 lakh after selling 25% ownership of your shop. At the end of the year, you generate ₹1 lakh in profit.
To calculate the return on equity (ROE), you divide the profit by the total shareholders’ funds, which is ₹5 lakh in this case. So, your ROE will be:
ROE = (Profit / Shareholders’ Funds) × 100
ROE = (1,00,000 / 5,00,000) × 100 = 20%
This means that for every ₹100 invested by the shareholders, your samosa shop is generating ₹20 in return. In simple words, ROE shows how well you’re using the money invested by the shareholders to generate profits.