The return on stockholders’ equity, or return on equity, is a corporation’s net income after income taxes divided by average amount of stockholders’ equity during the period of the net income.

To illustrate, let’s assume that a corporation’s net income after tax was $100,000 for the year 2007. Let’s also assume that it did not have any preferred stock outstanding and that its stockholders’ equity was $950,000 at the beginning of 2007 and was $1,050,000 at the end of 2007. The increase was at a uniform rate throughout the year. The return on stockholders’ equity will be 10% ($100,000 divided by the average stockholders’ equity of $1,000,000).

If a corporation has preferred stock outstanding, the relevant name is return on common equity and will be calculated as follows: net income after tax minus the required dividends on its preferred stock, divided by the average amount of common stockholders’ equity during the period of the income.

As with most ratios, you should compare your corporation’s return on equity with the ratio for other corporations in your industry.

Download our Return on Stockholders’ Equity Form and Template.

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About the Author: Harold Averkamp (CPA) has worked as an accountant, consultant, and university accounting instructor for more than 25 years.

He is the creator of the AccountingCoach Pro which has been praised for its ability to simplify accounting in a way that anybody can understand.

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