Certified Management Accountant Practice Exam

Return on Equity (ROE) is a key financial metric used to assess a company's profitability relative to shareholders' equity. The formula for calculating ROE is indeed Net Income divided by Total Equity. This calculation allows stakeholders to determine how effectively a company is using the equity invested by its shareholders to generate profits.

To put it in context, by using net income in the numerator, ROE reflects the earnings available to equity holders after all expenses, including taxes and interest, have been deducted. The denominator, total equity, represents the portion of the company financed by shareholders, which includes common stock, retained earnings, and other equity items. A higher ROE indicates a more efficient use of shareholders' equity, which is often desirable for investors.

In contrast, the other provided formulas do not accurately represent ROE:

- The formula involving Net Income/Total Assets measures Return on Assets (ROA), which highlights how efficiently a company is utilizing its assets to generate earnings.

- Total Revenue/Total Liabilities does not align with any widely accepted metric for return, as it mixes revenue with liabilities instead of focusing on equity.

- Operating Income/Shareholder Equity represents a different relationship; operating income does not account for all costs (like interest and taxes), making it