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Also known as a return on equity, Return On Net Worth (RONW) describes the portion of net income that is eventually returned as a percentage of the equity held by shareholders in a company. This particular calculation makes it easier to understand how much profit the business is generating with the investments provided by the shareholders. In this sense, the RONW is important to measuring whether the business is making the best use of those resources, or if there is a need to make changes that will help increase the percentage of return that is generated as a result of the shareholders equity.
There are several different approaches or formulas used to determine the return on net worth. A basic approach calls for dividing the net income for a specified period by the shareholders equity as it stood during that same period. Another approach calls for using an average of shareholders' equity over the period rather than the actual equity as of a particular date. Some firms also choose to omit dividends on preferred stocks from the net income while also subtracting the preferred equity from the shareholders equity for the period under consideration. The exact number of variables involved is often influenced by what the company wishes to achieve with the calculation.
Determining the RONW may be a common element of closing out a specific billing or revenue period. When this is the case, companies focus attention on how the net income and the shareholders' equity stand as of the last day of that period. The percentage that results from the calculation can then be compared to previous periods, providing the business with a snapshot of whether the company is moving forward, remaining constant, or starting to lose ground in terms of its revenue generation. From this perspective, calculating the return on net worth can make it possible to identify an unfavorable change early on, isolate the reasons for the change, and take steps to correct the issue before lasting damage is done to the operation.
It is even possible to use the basic formula for a return on net worth to evaluate progress within a given period. For example, the business may determine what is known as a beginning RONW at the beginning of a business quarter, calculate another percentage along the middle of the period, and then do a third calculation once the quarter is closed. This approach makes it possible to address issues that affect the generation of revenue as well as expenses that reduce the amount of net income generated throughout the period. As a result, the potential of ending the quarter with a more desirable return on net worth is increased, a state of affairs that is good for both the company and its investors.