Return on Equity is calculated as

Return on Equity is calculated as

• A. Net Income / Total Equity
• B. Net Income / Total Assets
• C. Operating Income / Total Equity
• D. Net Income / Total Liabilities

Answer: (A)

Return on Equity shows how effectively a company uses the owners’ capital to generate profits. The right formula is net income divided by total equity because it relates the earnings actually available to shareholders to the amount of ownership capital invested in the business. Net income is the profit after all expenses and taxes, and total equity represents the owners’ stake (common stock, retained earnings, and other equity components). Using assets in the denominator would measure profitability relative to everything the company controls, not just the owners’ funds, which is a different metric (return on assets). Using operating income would ignore the impact of financing and tax effects, giving a misleading view of profitability for equity holders. Using liabilities in the denominator nonsensically ties earnings to what the company owes rather than what the owners own.

Return on Equity shows how effectively a company uses the owners’ capital to generate profits. The right formula is net income divided by total equity because it relates the earnings actually available to shareholders to the amount of ownership capital invested in the business. Net income is the profit after all expenses and taxes, and total equity represents the owners’ stake (common stock, retained earnings, and other equity components). Using assets in the denominator would measure profitability relative to everything the company controls, not just the owners’ funds, which is a different metric (return on assets). Using operating income would ignore the impact of financing and tax effects, giving a misleading view of profitability for equity holders. Using liabilities in the denominator nonsensically ties earnings to what the company owes rather than what the owners own.