Chartered Financial Analyst (CFA) Level 1 Practice Exam

Net Profit Margin is calculated using which formula?

1. Net Income / Revenue

2. Gross Profit / Revenue

3. Operating Income / Revenue

4. EBIT / Revenue

The correct answer is: Net Income / Revenue

Net Profit Margin is defined as a measure of a company's profitability that shows the percentage of revenue remaining after all operating expenses, interest, taxes, and preferred stock dividends have been deducted from total revenue. The formula for calculating the Net Profit Margin is: Net Profit Margin = (Net Income / Revenue) x 100 By using net income in the numerator, this calculation captures the net earnings of a firm, reflecting all costs associated with the business's operations, financing, and taxation, thus providing a comprehensive view of profitability. When expressed as a percentage, it allows for comparisons across different companies and industries, offering insights into how efficiently a company converts revenue into profit. The other formulas listed correspond to different profitability metrics. Gross Profit to Revenue relates to the gross profit margin, which only considers direct production costs. Operating Income to Revenue reflects the operating margin, focusing on earnings derived from regular business operations, excluding non-operating income and expenses. EBIT (Earnings Before Interest and Taxes) to Revenue is often used as a measure of operational efficiency, but it also does not account for interest and tax expenses, which are included in the net profit margin calculation. Thus, the calculation featuring net income is the most comprehensive measure of a company's overall profitability and provides the