Chartered Financial Analyst (CFA) Practice Exam Level 2

What financial measure reflects the relationship between net income and total revenue?

1. EBIT Margin

2. Profit Margin

3. Return on Investment

4. Gross Margin

The correct answer is: Profit Margin

The profit margin is the financial measure that specifically reflects the relationship between net income and total revenue. This metric provides insight into how much profit a company makes for each dollar of revenue generated. It is calculated by dividing net income by total revenue, and it is typically expressed as a percentage. A higher profit margin indicates that a company retains more profit from its sales after accounting for all expenses, which can signal good management of costs and a strong competitive position in its market. This measure is particularly valuable for comparing the profitability of companies within the same industry, offering a clear view of how well they convert revenue into profits. In contrast, the EBIT margin focuses on earnings before interest and taxes relative to total revenue, emphasizing operating performance without considering the effects of financing and tax structures. Return on investment looks at profitability in relation to the capital invested, while gross margin pertains to the relationship between sales and the cost of goods sold, before accounting for operating expenses. Therefore, the profit margin directly captures the net income to total revenue relationship, making it the correct choice.