Chartered Financial Analyst (CFA) Level 1 Practice Exam

What is Gross Profit Margin calculated as?

1. Gross Profit + Revenue

2. Gross Profit / Net Income

3. Gross Profit / Revenue

4. Net Income / Revenue

The correct answer is: Gross Profit / Revenue

The Gross Profit Margin is a key financial metric that assesses a company's financial health by revealing the percentage of revenue that exceeds the cost of goods sold (COGS). This calculation is done by dividing Gross Profit by Revenue. Gross Profit is determined by subtracting the cost of goods sold from total revenue, indicating how effectively a company is producing its goods and controlling costs associated with their production. The formula is thus represented as: Gross Profit Margin = Gross Profit / Revenue A high gross profit margin indicates that a company retains a significant portion of revenues as profit, which can be used for other expenses, investments, or reinvested back into the business. This ratio is particularly useful for comparing the profitability of companies within the same industry. The other options provided do not accurately reflect the calculation of Gross Profit Margin: - "Gross Profit + Revenue" does not provide a percentage and does not relate to profitability. - "Gross Profit / Net Income" uses net income, which is affected by other expenses and taxes, hence not a direct measure of gross profitability. - "Net Income / Revenue" calculates the net profit margin, which considers all expenses and income, rather than just the cost of goods sold. Overall, understanding the gross profit margin is crucial for