Last updated: 09th Sep 2025
Are you running a tight ship – or just burning resources? ROE reveals how much profit your business squeezes out of every dollar available (e.g., retained earnings, shareholder capital, equipment and property).
It’s expressed as a percentage (e.g., 15%). The higher it is, the more attractive your business is to investors and buyers.
What Is Return On Equity?
Return on equity (ROE) is a measure of how much profit you make from every dollar of equity in your business.
To find your ROE ratio, divide your total profits by your equity in the business.
Important!
Equity is the value of your assets (e.g., cash, inventory, investments and physical assets) once you’ve accounted for liabilities such as loan repayments, bills, wages and taxes owed.
Here’s the ROE formula to use:
- Return on equity = Net Income / Owner’s equity or Shareholder’s equity.
- Net income = Total income – Total expenses.
- Equity = Total assets – Total liabilities.
Equity is essentially the true worth of your business, once you have subtracted all your obligations.
- If you’re a sole operator or partnership, you (and your partner) will personally hold all the net assets/equity. This is what’s known as owner’s equity.
- If you’re a company that issues shares, multiple people may have an ownership stake. Shareholders’ equity refers to the value of the company held by shareholders.
Underpinning the ROE measurement are two other metrics that can be calculated separately: Return on Assets (ROA), and Financial leverage.
ROE can also be derived by multiplying ROA by Financial leverage.
- ROA = Net income / Assets. This expresses profit generated as a percentage per dollar of assets owned.
- Financial leverage = Assets / Equity. This gives you a measure of how much your business depends on debt relative to equity or share capital.
- Return on equity = ROA x Financial Leverage
Why Is ROE An Important Metric?
ROE is irrelevant for most mom and pop business owners.
For them, the business (e.g., local chicken shop) is a full-time job that pays them a wage. They never grow it into a separate, sellable entity. In that sense, it isn’t really an asset.
Eventually, it’s either passed down to children or wound up.
The sale itself often represents the biggest financial outcome – far more substantial than the wages you drew along the way.
The Sher family, for example, sold Chargrill Charlies, a chain of chicken shops, to a PE firm in 2023. The amount was undisclosed, but likely exceeded $50 million.
Above: ROE would have played a key part in Chargrill Charile’s valuation.
Important!
And any buyer – whether private equity, institutional, or individual – will want to see your ROE.
Why?
Because it allows investors to compare companies within the same industry. Specifically, how effectively a company is leveraging investors’ money to grow its profits.
That’s a big deal – because it ensures dividends get paid out.
It also allows for reinvestment in the business to keep it on a successful trajectory (and its valuation or share price rising).
(Related: Liquidity Ratios Guide For SMBs).
If you’re consistently growing your ROE, potential investors, buyers or shareholders will view you as a commercially astute SMB operator who is delivering a lot of shareholder value.
If you’re holding onto more of what you own but still growing your profitability at a pace, it’s a positive sign that you’re using equity wisely and running an efficient operation.
A good ROE indicates that:
- Your branding, pricing, management and processes are more dialled-in, meaning you need to spend less of your equity to keep profits on the rise.
- You’re making smart investments in things like physical infrastructure, research and development, or new ventures to boost your bottom line.
You’ll be better prepared to attract investment or sell your business for a decent price if you increase your ROE over time.
(Related: Best Crypto Exchanges In Australia).
Return On Equity Calculation Example.
Let’s take the example of a small food manufacturing and distribution business that owns a fully equipped property.
It owns a range of equipment, including a commercial kitchen, industrial appliances and cool rooms.
- Net income: After subtracting all of its materials, production overheads and operating expenses, the company’s net profit annually is $400k.
- Net value: Its assets are worth $2.5 million. Minus its liabilities (loan repayments, wages, tax), that puts the business’ equity at $1.6 million.
- ROE: Using the ROE formula, we divide $400,000 in profit by $1.6 million in equity to determine the company has a return on equity of 25%.
(Related: The Ultimate Guide to Capex For SMBs.)
What Is A Good ROE Ratio?
A ROE of around 20% can be considered good, but it depends a great deal on what kind of business you’re in and who you’re comparing yourself to.
Business Queensland suggests:
Important!
With current home loan interest rates between 5%-8%, you probably don’t want an ROE below 10%.
Of course, success in some industries is only possible through significant investment in physical plant or equipment, and high operating costs.
Both of which will dampen ROE, even if the company is doing well.
A higher ROE is desirable. But as with most financial metrics, an exceptionally high or variable ROE ratio could be suspect.
- High levels of debt can inflate an ROE.
- One-off spikes in income can skew ROE temporarily.
If we use the same food manufacturer from our earlier example, but we add $500,000 extra in liabilities through multiple borrowings, the company’s equity shrinks to $1.1 million.
That’s considerably higher than 25%.
But taking on so much debt adds risk — if cashflow dries up, highly leveraged companies can fall behind on repayments and things can quickly spiral.
How To (Safely) Improve Your Return On Equity.
So, if your ROE is below 10%, what can you do to lift it back into respectable territory?
The two major levers to pull are raising profits or reducing equity.
So, for example, a company with shareholders could quickly improve its ROE through a share buyback that lowers shareholder equity — but that doesn’t reflect a higher performing business.
Going into more debt will also decrease equity, and has the potential to fuel growth that drives profitability.
You’ll need to carefully do your sums to make sure the cost of servicing debt doesn’t eat into your returns too much.
Some strategies you should look into:
- Get serious about lifting your profit margin, without a commensurate lift in expenses. Simple examples include price hikes or sourcing less expensive products.
- Improve how you manage assets or stock. Reconsider your need for expensive equipment that rarely gets used, or holding excessive amounts of slow-moving products.
- Reduce costs without impacting your service/product quality by reducing wasteful spending and/or upgrading your technology, processes or people capabilities.
Ultimately, improving your ROE while enabling sustainable, long-term and low-risk growth requires honing your competitive advantages and running a cost-efficient operation.
Jody
