The amount of equity owners have in a business refers to their actual claim on the business in terms of assets versus liabilities. Oftentimes, a business will invest in a company’s available assets in order to generate profitable returns. When a business receives a good return on equity, it may or may not have to do with returns received on an investment.
Equity vs. Income
Businesses generate income as a means to earn profits, which allow them to expand and grow. When tracking income and expenses, businesses can reach a point where a certain amount of the income generated becomes actual asset holdings. Depending on the amount of liabilities involved, asset holdings can eventually represent the amount of equity owners have in the business. In effect, income revenues generate assets, which work towards building owner equity in the business. Income revenue can come from several sources, some of which include product sales, monies owed to the business and investment returns. The difference between a good return on equity and a return on investment has to do with what parts of a business’ operations contributed to its equity returns.
Return on Equity
A good return on equity has to do with how business owners manage existing assets and leverage available capital to reach their goals and objectives. Returns on equity can result from how a company’s stocks perform in the market, capital investments, cutting costs or any combination of a number of factors involved with the business. With capital investments, rates of return can vary and start out slow before building momentum over time. Capital investments may also lead to increased costs and expenses in other areas of the business at the outset. In effect, a good return on equity may take months or years to occur, depending on a business’ cash flows as an investment project takes root.
Return on Investment
Business investments can take the form of developing new product lines, building expansions or research and development projects. The type of investment involved determines the rate in which a company sees a return on its investment as well as any related start-up costs. To determine return on investment, accountants divide the amount of net profits generated by the total assets of the company. As assets represent a portion of a company’s equity holdings, a return on investment will appear as a percentage of the company’s equity holdings, meaning the higher the percentage, the better the return.
Earnings Growth vs. Equity Growth
Earnings growth versus equity growth refers to the returns generated by an investment and how these returns impact a business’ equity holdings. In effect, returns from an investment can add to a company’s equity holdings as long as any associated costs and existing liabilities don’t absorb the profits made. In terms of profitability, businesses can use return on investment values during the pre-planning stages to determine how a particular investment will perform when compared to other investment options. Businesses can also calculate rate of return values in terms of how they impact equity holdings.