Certified Management Accountant Practice Exam

What formula is used to calculate profit margin?

1. Net Income / Average Assets

2. Net Income / Sales

3. Total Revenue / Total Costs

4. Sales / Total Assets

The correct answer is: Net Income / Sales

The formula used to calculate profit margin is derived from the relationship between net income and sales. Profit margin is a profitability ratio that demonstrates how much profit a company makes for every dollar of sales after all expenses are deducted. To calculate profit margin, you take net income, which is the company’s total revenue minus its total expenses (including cost of goods sold, operating expenses, interest, taxes, etc.), and divide that by total sales. This calculation gives you a percentage that indicates the portion of sales revenue that has turned into profit. A higher profit margin signifies that a company is more efficient at converting sales into actual profit. This understanding of profit margin is crucial for financial analysis, as it allows management and investors to assess profitability relative to sales volume, which can provide insights into cost control, pricing strategies, and overall business health.