Table of contents

1. Introduction to Accounting1h 21m
2. Transaction Analysis1h 13m
3. Accrual Accounting Concepts2h 38m
4. Merchandising Operations2h 30m
5. Inventory1h 55m
6. Internal Controls and Reporting Cash1h 16m
7. Receivables and Investments3h 8m
8. Long Lived Assets5h 1m
9. Current Liabilities2h 19m
10. Time Value of Money1h 23m
- Time Value of Money Equations
  35m
- Using Time Value of Money Tables
  47m
11. Long Term Liabilities2h 45m
12. Stockholders' Equity2h 15m
13. Statement of Cash Flows2h 24m
14. Financial Statement Analysis5h 25m
15. GAAP vs IFRS56m

14. Financial Statement Analysis

Ratios: Return on Equity (ROE)

Financial Accounting

14. Financial Statement Analysis

Ratios: Return on Equity (ROE)

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Multiple Choice

Which one of the following is a correct formula for computing the Return on Equity (ROE)?

ROE = \frac{Net\ Income}{Average\ Shareholders'\ Equity}

ROE = \frac{Total\ Assets}{Net\ Income}

ROE = \frac{Net\ Income}{Total\ Liabilities}

ROE = \frac{Gross\ Profit}{Shareholders'\ Equity}

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Verified step by step guidance

Step 1: Understand the concept of Return on Equity (ROE). ROE is a financial ratio that measures the profitability of a company in relation to its shareholders' equity. It indicates how effectively the company is using the equity invested by shareholders to generate profits.

Step 2: Identify the correct formula for ROE. The formula is ROE = \frac{Net\ Income}{Average\ Shareholders'\ Equity}. This formula calculates the percentage return generated on the equity invested by shareholders.

Step 3: Break down the components of the formula: Net Income represents the company's profit after all expenses, taxes, and costs have been deducted. Average Shareholders' Equity is the average of the equity at the beginning and end of the period being analyzed.

Step 4: Compare the given options to the correct formula. The correct formula matches the first option: ROE = \frac{Net\ Income}{Average\ Shareholders'\ Equity}. The other options are incorrect because they use inappropriate components such as Total Assets, Total Liabilities, or Gross Profit.

Step 5: Apply the formula in practice by substituting the values for Net Income and Average Shareholders' Equity from the financial statements of a company to compute the ROE. This will provide insight into the company's profitability relative to shareholder investment.