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Return on Equity Ratio

This ratio reflects the return on shareholders funds that the business enterprise was able to earn. It is calculated as:

[Net Income After Taxes / Average Shareholders’ Fund] x 100

Components: The proprietor’s equity or funds include the paid up value of the equity as well as preference share capital. To this are added all uncommitted capital and revenue reserves and retained earnings. Since the amount of paid up equity and preference capital may not remain same during the accounting period, it is desirable to take an average of the shareholders’ funds e.g. : Beginning Shareholders’ Funds + Ending Shareholders’ Funds/2

Uses and interpretation: The proprietors or shareholders are primarily interested in the profit-earning capacity of the business in which their funds are invested. If the profits earned by the firm are insufficient, it will fail to attract funds for expanding operations since additional capital will not be available.

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