If you are looking for the exact return on networth / equity formula, the good news is that it is short. The better news is that a few variations can make your analysis much more reliable. This guide gives the formula, shows how to use it in a spreadsheet and explains the version that breaks it into parts.
The basic formula
Return on equity (also called return on net worth, or RONW in India) equals net profit after tax divided by shareholders’ equity, multiplied by 100. Net profit comes from the income statement, and equity from the balance sheet.
| Version | Formula | When to use it |
|---|---|---|
| Simple | Net profit ÷ closing equity × 100 | Quick checks |
| Average equity | Net profit ÷ ((opening + closing equity) ÷ 2) × 100 | Most analysis |
| DuPont | Margin × asset turnover × equity multiplier | Finding the source of the return |
Using average equity
Equity changes during the year, because of profits, dividends and new share issues. Using the average of opening and closing balances matches profit earned over the whole year with the capital that was available. If a company raised a lot of money late in the year, the closing balance would overstate the capital used.
Worked example: the return on networth / equity formula in numbers
A company reports net profit after tax of 18 million. Opening equity is 120 million and closing equity is 140 million. Average equity is 130 million. Return on net worth is 18 divided by 130, or about 13.8 percent. With the simple version, using closing equity, the result would be 18 divided by 140, or 12.9 percent. The difference shows why you must state which version you used.
The DuPont breakdown
DuPont analysis splits the return into three parts:
- Net profit margin (net profit ÷ revenue) shows how much profit each unit of sales produces.
- Asset turnover (revenue ÷ total assets) shows how efficiently assets generate sales.
- Equity multiplier (total assets ÷ equity) shows how much the company relies on borrowing.
Multiply the three and you get return on equity. If two companies have the same ROE but one has a high multiplier, it is riskier, because more of its return comes from borrowing.
Doing it in a spreadsheet
Place net profit in one cell, opening equity in another and closing equity in a third. The formula for the average version is profit divided by the average of the two equity cells, multiplied by 100. Fill it across several years to see the trend. Add a column for debt to equity so you can see whether returns are driven by leverage.
Common pitfalls
- Do not use revaluation reserves if the definition excludes them, as in Indian company law.
- Be careful with negative equity, which makes the ratio meaningless.
- Remember that one-off gains can distort a single year.
- Compare companies in the same industry.
Where to read more
Our overview of return on networth / equity explains how to interpret the ratio, and the article on networth as per the Companies Act 2013 shows how net worth is defined in India. For personal finance, see calculating your networth.
Quick questions readers ask
Is RONW different from ROE? Usually not. Should I use average equity? Yes, for most analysis. What is a good ratio? It depends on the industry.
A second worked example with leverage
Take two firms with the same net profit of 10 million. Firm A has equity of 50 million and no debt, giving a return of 20 percent. Firm B has equity of 25 million and borrowed 25 million, so its return is 40 percent. At first glance B looks twice as good, but its equity multiplier is double, meaning a downturn would hit its shareholders much harder. This is why analysts pair the formula with debt measures and look at several years, so that a single strong year or a heavily borrowed balance sheet does not mislead.
In short
The return on networth / equity formula is profit divided by equity, but accuracy improves when you use average equity and examine the DuPont parts. Always state your version and compare like with like.
This article is educational and not investment advice.
Featured image: Wikimedia Commons, public domain / CC0.
