Certified Financial Management Specialist Practice Exam

Which measure reflects the company's profitability in relation to the shareholders’ equity?

1. Return on investment (ROI)

2. Return on equity (ROE)

3. Return on assets (ROA)

4. Net profit margin

The correct answer is: Return on equity (ROE)

Return on equity (ROE) is the measure that specifically reflects a company's profitability in relation to its shareholders' equity. It is calculated by dividing net income by the average shareholders' equity. This ratio indicates how effectively management is using the equity invested by shareholders to generate profits. A higher ROE signifies that the company is able to generate more profit per dollar of shareholders' equity, which is generally favorable from an investor's perspective. In contrast, return on investment (ROI) is a broader measure that looks at the profitability of an investment as a whole, not specifically tied to shareholders' equity. Return on assets (ROA) measures how efficiently a company can manage its assets to generate earnings, which is different from focusing solely on equity. The net profit margin indicates how much profit a company makes for every dollar of revenue, but it does not assess profitability relative to shareholders' equity. Therefore, ROE provides the clearest insight into how well a company is utilizing its shareholders' equity to create value.