Finance Formulas / July 6, 2018 / Alyvia French
An individual starts a business and incurs startup costs of $50,000. During the first year of operation, the business earns a profit of $75,000. If the individual had stayed at his previous job, he would have made $30,000. In this example, the accounting profit is $25,000, or $75,000 - $50,000. However, because the individual had the potential to earn income at another location while retaining the startup costs of the business, an economic loss of $5,000, or $25,000 - $30,000, is incurred. Although an accounting profit occurred, the individual would have made a larger profit if he had stayed in his previous position.
Return on equity (ROE) measures the rate of return on the ownership interest or shareholders’ equity of the common stock owners. It is a measure of a company’s efficiency at generating profits using the shareholders’ stake of equity in the business. In other words, return on equity is an indication of how well a company uses investment funds to generate earnings growth. It is also commonly used as a target for executive compensation, since ratios such as ROE tend to give management an incentive to perform better. Returns on equity between 15% and 20% are generally considered to be acceptable.
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