Components of Return on Equity
Return on Equity has three ratio components. The three ratios that make up Return on Equity are:
1. Profit Margin = Net Income / Sales
2. Asset Turnover = Sales / Assets
3. Financial Leverage = Assets / Equity
Profit Margin measures the percent of profits you generate for each dollar of sales. Profit Margin reflects your ability to control costs and make a return on your sales. Profit Margin is calculated by dividing Net Income by Sales. Management is interested in having high profit margins.
EXAMPLE — Net Income for the year was $ 60,000 and Sales were $ 480,000. Profit Margin is $ ...