Return on equity is a financial assessment of how efficiently a company is generating profit relative to its shareholders' equity. To improve return on equity, you can optimize revenue and costs or implement certain financial maneuvers.
One way to improve return on equity, or ROE, is to generate greater revenue without taking on more investment equity. A March 2011 Standard Bank press release described the company's strategies to improve ROE by expanding global operations. By entering or expanding in foreign countries, the business is able to build new revenue streams. Selling more goods to existing customers, attracting new market segments and diversifying your product mix are additional growth strategies that may improve revenue.
To enhance profit or returns, you must balance revenue growth with cost management. Therefore, another way to raise ROE is to maintain costs while revenue grows or to cut costs. A company may close down unprofitable business centers to eliminate inefficient costs, for instance. Trimming your workforce is another common cost-cutting measure, though you must ensure that the loss of these positions doesn't reduce significant revenue contributions. Reducing utility expenses is another savings strategy.
A financial maneuver used to increase ROE is the buyback of stock shares. When a company buys back shares from owners, it reduces the amount of shareholders' equity. Thus, with no change to net income, ROE on equity goes up. If net income for the year is $1 million and shareholders' equity is $5 million, ROE is 20 percent. If the company buys shares to reduce owners' equity to $4 million, ROE becomes 25 percent.
Various risks or challenges should be considered when trying to improve ROE. Your business may become stretched too thin if it aggressively pursues new customer bases or products. This tactic may lead to difficulty in the long run of maintaining quality product and service standards and stabilizing earnings. Therefore, you could erode your business model, profit and ROE over time. Buying back shares improves ROE, but it doesn't affect profitability. And you either have to use cash or take on new debt to buy back shares. This move is risky if you aren't in good financial health as a company.