Return on equity

Return on equity relates a period's net income to the average accounting equity supporting the entity. Harbor reports $24,000 net income and $80,000 average equity:

$24,000 ÷ $80,000 = 30% ROE

The percentage is separate from a shareholder's stock-price return, dividend yield, or cash distribution rate. It is an accounting relationship under the declared entity and equity definitions.

OpenStax Section 6.6 presents ROE beside return on assets. ROA uses average assets; ROE uses average equity. The shared net-income numerator does not make the measures interchangeable.

Reconcile the denominator

Harbor begins with $75,000 equity, earns $24,000, receives no owner contributions, and distributes $14,000:

$75,000 + $24,000 − $14,000 = $85,000 ending equity

The average is $80,000. The rollforward matters because a denominator should not enter the workpaper as an unexplained database field. Accounting learners should tie it to the statements. Finance learners should ask how distributions, buybacks, losses, or other equity changes affect the ratio.

Separate operating return from financing amplification

Harbor and Beacon both report 12% ROA. Harbor's equity multiplier is 2.50; Beacon's is 2.00:

Harbor: 0.12 × 2.50 = 0.30 = 30% ROE
Beacon: 0.12 × 2.00 = 0.24 = 24% ROE

Harbor's higher ROE is not evidence of higher ROA. It is the mathematical effect of more assets per equity dollar under these facts. That distinction changes the next question from “Which company operates better?” to “What claims finance the assets, at what cost, maturity, and risk?”

High ROE can be fragile

A small equity denominator can make ROE large. Distributions or repurchases can reduce equity and raise the ratio even when net income is unchanged. Losses can drive equity toward zero or below it, making ordinary comparisons unstable. Accounting estimates, impairments, acquisitions, preferred claims, and noncontrolling interests can also alter the numerator or denominator.

Harbor's own $14,000 distribution shows this mechanism. The distribution is not an expense and does not reduce net income. It does reduce ending equity and therefore affects the average-equity denominator.

Positive ROE does not prove cash generation. Beacon's operating cash exceeds net income while Harbor's falls below it in the fictional packet. One year of either pattern is a prompt to inspect the bridge and trend, not a quality label.

ROE becomes useful when it is decomposed, reconciled, and bounded. A single ranking discards the very information the ratio can help uncover.