Return on Net Worth
It is a ratio expressed in percentage terms. Return on Net Worth Calculator is used to calculate the profits earned by the company on the investments made by shareholders of the company. We calculate it from the investors` point of view rather than the company’s point of view. It becomes a useful tool while comparing two companies of the same industry. It is also known as return on equity.
Formula for Calculating Return on Net Worth
For calculating return on net worth, divide the shareholders’ equity by net income. The formula for calculating the same is as follows.
Return on Net Worth = Net Income / Shareholder`s Equity
About the Calculator / Features
The calculator provides the result of the calculation instantly with a click of the user after the user provides the following data to the calculator.
- Net Income.
- Shareholder’s Equity.
How to Calculate using Calculator
The user has to insert the following details into the calculator.
Net Income can be obtained from the income and expenditure statement of the company. It is net off of all the expenses, including interest paid to debt holders of the company. Net Income is that portion of earnings that is available for distribution among shareholders after the company pays off all its expenses. Moreover, it is the earnings available for the equity shareholders. Hence, preference dividends will also be excluded.
Shareholders’ equity can be calculated by subtracting total liabilities from total assets. It is the owners` claim on assets after paying off debt. In other words, all those belong to Equity Shareholders will become this figure. Hence, preferred equity will be excluded. We can call it the Shareholders’ Kitty also to convey the same meaning. Thus, this is the total investments of Shareholders in the company, including the retained earnings, reserves, and surplus, over the years.
Example of Return on Net Worth
Let us understand this concept with the help of a simple example. Following are the details of XYZ ltd. Calculate the return on the net worth from the following data.
|Shareholders` Equity (Shareholders’ Kitty)||800,000|
RoNW = 200,000 / 800,000 = 0.25 or 25%
Interpretation of Return on Net Worth
Return on net worth shows the ability of the company to earn profits on shareholders’ investments in the company. In the example above, it is 25%. An increase in net income will increase this ratio, which will eventually determine the company’s efficiency in earning higher profits with the same level of capital. Similarly, a decrease in net income will decrease the return on net worth ratio, and this indicates the inefficiency of the company to generate higher profits or generate profits at the same level. Therefore, a higher return on net worth is always better and preferable.
A higher return on net worth indicates that the management of the company is well-efficient in managing the capital of the company. Higher returns attract new investors and new investments from the existing investors.
Also, a decreasing return on net worth indicates that the company is not able to generate enough profits and deploy funds efficiently, its operating cost is more, or the cost of debt funding is more.
To arrive at a conclusion on how the company is managing its fund, one should always take a look at the return on the net worth of a multi-year period. A single year’s return on net worth is not enough to interpret the company’s overall performance. Hence, any decision to invest or otherwise should not be based on a single year’s return. In addition, the status of the industry, in general, should also be taken into consideration before arriving at any decision.
Moreover, a higher return on net worth may be a result of the buyback of shares during the year. This may reduce the overall kitty; thus, there could be a sudden jump in return due to which one can make a wrong interpretation. So proper evaluation and digging are a must.