Chartered Financial Analyst (CFA) Practice Exam Level 2

What is the formula for calculating Gross Profit Margin?

1. Gross Profit / Net Profit

2. Gross Profit / Sales

3. Sales - COGS / Sales

4. Sales - Gross Profit / COGS

The correct answer is: Gross Profit / Sales

The formula for calculating Gross Profit Margin is correctly represented by Gross Profit divided by Sales. Gross Profit is defined as the difference between Sales and the Cost of Goods Sold (COGS). By taking this ratio, one can assess the percentage of revenue that exceeds the costs directly associated with producing the goods sold by a company. This calculation is significant as it provides insight into the company's financial health and operational efficiency. A higher Gross Profit Margin indicates that a company retains a larger portion of revenue after accounting for the costs associated with its goods, which is favorable for profitability. In contrast to other options, they do not accurately represent the Gross Profit Margin. Some propose alternative calculations involving profits or costs improperly, leading to incorrect interpretations of profitability. For instance, looking at gross profit in relation to net profit or using incorrect denominators would not yield insight into the specific contribution of sales revenue toward covering production costs.