Return on Equity (ROE) Explained for SMEs

Anyone who invests equity in a company wants to know whether that investment is worthwhile. Return on equity—also known internationally as “ROE”—answers exactly that question. It shows how efficiently your company is utilizing its invested equity.

What is return on equity?

Return on equity indicates what percentage of the equity capital invested is returned to the owners as profit. It thus links the income statement and the balance sheet and provides a comprehensive assessment of your company’s profitability. The higher the return on equity, the more attractive your company is from the owners’ perspective.

This metric is particularly useful for SME owners to assess whether the capital tied up in the business is generating an appropriate return—compared, for example, to alternative investment options.

Why is return on equity important for SMEs?

For SME owners, ROE is a key indicator. It shows whether the money you have invested in your business is generating a sufficient return. A return on equity of 4 percent, for example, means that your business generates 4 centimes in profit for every franc of equity invested.

This metric is also relevant for potential investors or successors. In the event of a business sale or succession planning, return on equity is a key element of the valuation.

Calculating Return on Equity

The formula is simple: divide annual profit by equity and multiply the result by 100. Equity is typically calculated as the average value over the fiscal year or the balance sheet value at the beginning of the period.

A concrete example

Imagine your company has equity of 500,000 Swiss francs and generates an annual profit of 50,000 Swiss francs. The return on equity is then: 50,000 divided by 500,000 times 100 equals 10 percent.

This means that your company generates 10 centimes in profit for every franc of equity capital invested—a figure that is considered solid to very good, depending on the industry.

What constitutes a good return on equity?

A good return on equity is generally well above the interest rate of a low-risk investment. In Switzerland, figures ranging from 8 to 15 percent are considered solid in many industries. Rates above 20 percent are excellent but should be viewed critically—they may also indicate a particularly thin equity base.

A high ROE isn’t always a good sign: If your company has very little equity and is heavily leveraged, the return on equity may appear artificially inflated. That’s why you should always consider this metric in conjunction with the equity ratio.

Limitations of the metric

Return on equity is a snapshot and can be distorted by one-time effects. Extraordinary income, the release of provisions, or unusually low investments can drive the metric upward without actual improvements in operating performance. Viewing it in isolation is therefore not very meaningful.

Findea is happy to help you properly interpret return on equity and place it within the overall context of your company’s financial metrics.

The Complete Guide at a Glance

This article is part of our comprehensive series on the most important financial metrics for Swiss SMEs. In the complete guide to the 10 most important financial metrics for SMEs, you’ll find all metrics at a glance—from profitability and liquidity to financing structure.

Formula: Return on Equity (ROE)

Return on Equity (%) = (Net Income ÷ Equity) × 100

Recommended: Use average equity for the period