Return on Shareholders Investment or Net Worth Ratio:

Definition:

It is the ratio of net profit to share holder's investment. It is the relationship between net profit (after interest and tax) and share holder's/proprietor's fund.
This ratio establishes the profitability from the share holders' point of view. The ratio is generally calculated in percentage.

Components:

The two basic components of this ratio are net profits and shareholder's funds. Shareholder's funds include equity share capital, (preference share capital) and all reserves and surplus belonging to shareholders. Net profit means net income after payment of interest and income tax because those will be the only profits available for share holders.

Formula of return on shareholder's investment or net worth Ratio:

[Return on share holder's investment = {Net profit (after interest and tax) / Share holder's fund} × 100]

Example:

Suppose net income in an organization is $60,000 where as shareholder's investments or funds are $400,000.

Calculate return on shareholders investment or net worth

Return on share holders investment = (60,000 / 400,000) × 100

= 15%

This means that the return on shareholders funds is 15 cents per dollar.

Significance:

This ratio is one of the most important ratios used for measuring the overall efficiency of a firm. As the primary objective of business is to maximize its earnings, this ratio indicates the extent to which this primary objective of businesses being achieved. This ratio is of great importance to the present and prospective shareholders as well as the management of the company. As the ratio reveals how well the resources of the firm are being used, higher the ratio, better are the results. The inter firm comparison of this ratio determines whether the investments in the firm are attractive or not as the investors would like to invest only where the return is higher.