Return on earnings is a financial measure used to evaluate how effectively a company generates profits from the earnings it retains rather than distributing them as dividends. Investors and business owners use this metric to assess whether retained earnings are being invested efficiently to increase profitability and business growth. Calculating return on earnings helps measure management performance and supports better investment and financial decisions.
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Determine the Net Income
Start by identifying the company’s net income for the financial period.
Net income is the profit remaining after deducting all operating expenses, interest, taxes, and other costs from total revenue.
- Obtain the income statement
- Record the net income
- Verify the reported profit
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Determine the Retained Earnings
Identify the retained earnings shown in the company’s balance sheet.
Retained earnings represent the cumulative profits kept in the business after paying dividends to shareholders.
- Review the balance sheet
- Record the retained earnings
- Confirm the reported amount
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Apply the Return on Earnings Formula
Use the following formula to calculate the return on earnings:
Return on Earnings = (Net Income ÷ Retained Earnings) × 100
For example, if a company has a net income of Sh 500,000 and retained earnings of Sh 2,000,000, then:
Return on Earnings = (Sh 500,000 ÷ Sh 2,000,000) × 100
Return on Earnings = 25%
This means the company generated a 25% return on its retained earnings during the financial period.
- Divide net income by retained earnings
- Multiply the result by 100
- Record the percentage return
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Interpret the Results
A higher return on earnings generally indicates that the company is using its retained earnings efficiently to generate profits.
A lower percentage may suggest that retained earnings are not producing strong returns or that profits have declined.
- Compare the result with previous years
- Evaluate business performance
- Consider industry benchmarks
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Review the Calculation Regularly
Calculate the return on earnings each financial year to monitor trends in profitability and business growth.
Regular analysis helps investors and business owners determine whether retained earnings are being managed effectively.
- Calculate the ratio annually
- Compare yearly performance
- Use the results for decision-making
Also Read: How to Calculate Pips on Forex
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