Return on common stockholders' equity demonstrates how efficiently a company uses the investment of its common stockholders. When a company has not issued preferred shares, return on common stockholders' equity may be referred to as return on shareholders' equity. A high return on common stockholders' equity indicates the company is efficiently using common stockholder investment to acquire assets and generate revenue. Compare a company's return on common stockholders' equity with other businesses in the same industry to accurately assess the overall financial health of a business.
1. Calculate the company's net income. A company's net income can be found on the income statement. Net income can be determined by adding revenues and subtracting expenses, which yields the company's pretax income. Subtract income taxes from pretax income to determine the company's net income. For instance, a company with $250,000 total revenue and total expenses of $125,000 has a pretax income of $125,000. In this case, a company with $50,000 in income tax expense will have $75,000 net income.
2. Add the company's beginning common stock balance with the ending common stock balance. Assuming a company began with $100,000 in common stock and ended with $150,000, the result yields $250,000.
3. Divide the sum of beginning common stock with ending common stock. Assume the sum of a company's beginning common stock and ending common stock is equal to $250,000. Divide $250,000 by two, which is equal to $125,000. In this scenario, the $125,000 represents the company's average common stockholders' equity.
4. Divide net income by average common stockholders' equity. If the net income is $75,000 and average common stockholders' equity is equal to $125,000, then return on common stockholders' equity equals .60 or 60 percent.
Items you will need
- Income Statement