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8.11 Return on Equity Analysis

The Return on Equity Ratio measures the ability of a small business like Lights On Electrical, Inc. to be able to generate bottom line Income (Net Income) for its shareholders and is a key ratio that is looked at by lenders and especially potential partners when they are looking to either lend money to the business in the form of a business loan or make an investment into the business.

We are projected that for the return on equity for Andy and Jose of Lights On Electrical will be 36.8%, 34.6% and 29.2% for 2015, 2016 and 2017 respectively. What this implies is that for every $1 invested in Lights On Electrical by Andy and Jose they will generate 36 cents in 2015, 34 cents in 2016 and 29 cents in 2017. This is an excellent return on the initial amount invested and all retained earnings invested back in to the business for both Andy and Jose.

Net Income is of course the final net income from which the shareholders / owners will get paid and it is projected that the net income for the next three years will be $44,317, $63,667 and $75,875 respectively. Total equity that includes the original contribution from shareholders adjusted for retained earnings and distributions is projected to be $120,317, $183,984 and $259,859 respectively. It is important to note that the net income included here already has accounted for the salaries to both Andy and Jose.

The reason for the decline in the return on equity for the second and third year is the fact that all the retained earnings will be added back to the business by both Andy and Jose. This of course increases the total equity that both the owners have in the firm. The rationale behind investing the cash surplus is to be able to build up a solid cash reserve that is needed when one goes after larger contracts. Surety bonds require a very high level of equity in the business to be able to provide the higher levels of bonding that is required with larger projects. Once sales start growing, we anticipate that the Net Income for the Lights On Electrical will also grow proportionately resulting in improving return on equity ratios.

Quick Links:

  1. Go to the Corresponding Template section for this industry.
  2. Go to the Corresponding Questionnaire section for this industry.

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