Chartered Financial Analyst (CFA) Practice Exam Level 2

What does Net Profit Margin (NPM) measure?

1. Sales / Net Profit

2. Net Profit / Sales

3. Gross Profit / Sales

4. Operating Income / Sales

The correct answer is: Net Profit / Sales

Net Profit Margin (NPM) measures the percentage of revenue that remains as profit after all expenses have been deducted from sales. It is calculated by dividing net profit (or net income) by total sales (or revenue). This ratio is important because it reflects how effectively a company is managing its costs and expenses relative to its total revenues, providing insight into profitability and company efficiency. A higher net profit margin indicates a company is more efficient at converting sales into actual profit, which can be particularly useful for comparing performance across companies in the same industry. This measure allows investors and analysts to assess how well the company controls its costs and how successful it is at turning sales into actual earnings. Other options represent different financial metrics: - Sales / Net Profit expresses the inverse relationship and does not indicate profitability, - Gross Profit / Sales focuses on the profitability of production and does not consider operating and other expenses, - Operating Income / Sales provides insights into operational efficiency but excludes non-operating income and expenses, making it distinct from net profit analysis.