Chartered Financial Analyst (CFA) Level 1 Practice Exam

Which formula represents Operating Margin?

1. Operating profit / Revenue

2. Net profit / Revenue

3. Gross profit / Revenue

4. EBIT / Revenue

The correct answer is: Operating profit / Revenue

The formula for Operating Margin reflects the company's operational efficiency by measuring the portion of revenue that remains after covering operating expenses, which includes the cost of goods sold (COGS) and operating expenses but excludes interest and taxes. Thus, operating margin is calculated as Operating profit divided by Revenue. Operating profit, also known as operating income or EBIT (Earnings Before Interest and Taxes), indicates the profit generated from the core business operations before any non-operating income and expenses are considered. By dividing operating profit by total revenue, you can assess the percentage of revenue that translates into operating profit, which is crucial for evaluating the performance and profitability of a company's core business activities. The other options reflect different profitability metrics: Net profit considers all expenses including taxes and interest, Gross profit focuses solely on revenue minus COGS, and EBIT/Revenue, while similar to operating profit, does not specifically denote the operational effectiveness of a company's regular business operations relative to all revenue.