A company uses many ratios and percentages to attain the profit and loss and some other factors that give information about the business. They are very important for the decision making of an enterprise both to the external and internal sources. Two of those terms are Return on Equity and Return on Net Worth. They both are kind of used in place of each other but do have some distinction between them.
Return on Equity vs Return on Net Worth
The main difference between the two percentages that show the company their returns is that return on Equity is that 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.
Return on Equity is used to measure the profitability of the business. To calculate a company’s Return on Equity, one must simply divide the Net Income by its average shareholders’ Equity. It is primarily a measure of the return that is generated by the company’s net assets.
Return on Net Worth also indicates the profitability that a company has over its Net Worth that is also known as the capital of the firm. A Net Worth or Capital represents the total value of the company. Net Worth includes shareholders Equity, Reserves, preference share capital, securities, etc.
Comparison Table Between Return on Equity and Return on Net Worth
| Parameters of Comparison | Return on Equity | Return on Net Worth |
| Abbreviation | RoE | RONW |
| Definition | Used to measure the profitability of the business in relation to Equity. | Used to calculate the percentage of profit from the net income and net worth of the company. |
| Usage | It is especially 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 or not. |
| Disadvantage | The ratio can be manipulated. | The ratio is made from the perspective of the investors and not the company. |
| Formula other name | N/A | Return on Capital |
What is Return on Equity?
Return on Equity, or rather RoE, is the number of earnings or profits a company generates 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 of common, preferred and retained shares.
Following is the way to calculate Return on Equity:
- Take the net income of the business (annual).
- Get the shareholders Equity.
- Divide the net income to shareholders Equity.
Since Equity is assets minus the liabilities of the company, Return on Equity can also be thought of as another way to calculate the ratio.
A common way to calculate ROE is by DuPont Formula as well because using this formula it makes easier to understand the changes over a long period of time. 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 dividend 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 the percentage that a company has in profitability. It calculates the percentage of return that the company is getting over a time period. 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 not only shareholders Equity but also Reserves, preference share capital.
A Higher Ratio of RoNW indicates that a company is nicely utilizing the money of the shareholders in an efficient manner. If the return comes on negative, the company would not be able to raise funds from the market, which is a big loss for any business. In order 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 made only on the money that is invested by the equity shareholders of the company. Return on Net worth can be on anything that a company has meaning, loans, debentures, securities of the company.
- Return on Net Worth has more features on it as it comprises of more materials of the company like debentures and securities, while Return on Equity is only used to calculate the shareholders’ equity.
- Return on Net Worth is a bigger term in comparison to 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 basically their return on money. Return on Net Worth is more useful 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.
Conclusion
Return on Equity and Return on Net Worth are both current accounting value of the assets less the debt of the company. They are the after-tax benefits of the enterprise divided after the accounting value. These ratios are very important as they play a necessary part in the calculation of the overall finance of an enterprise.
Though they do have a minimal difference, that is the reason for the confusion for using the two in exchange for each other. The actual meaning can create a difference in the company’s finances.
References
- https://books.google.co.in/books?id=RKaZAAAAIAAJ&q=return+on+net+worth&dq=return+on+net+worth&hl=en&sa=X&ved=2ahUKEwiPxOrxvJLwAhWezzgGHRvMCLYQ6AEwBXoECAYQAw
- https://books.google.co.in/books?id=cwODDwAAQBAJ&printsec=frontcover&dq=return+on+Equity&hl=en&sa=X&ved=2ahUKEwijoZGUvZLwAhVIxzgGHZeKA7oQ6AEwAHoECAIQAw#v=onepage&q=return%20on%20Equity&f=false