Chartered Financial Analyst (CFA) Practice Exam Level 2

How is Profit Margin calculated?

1. Earnings Before Interest and Taxes / Revenue

2. EPS / Revenue per share

3. Net Income / Total Assets

4. Operating Income / Total Revenue

The correct answer is: EPS / Revenue per share

The calculation for Profit Margin typically involves dividing net income by total revenue. Profit Margin is a financial metric used to assess a company's profitability and is typically expressed as a percentage. In this context, while the answer provided is EPS / Revenue per share, this does not accurately represent the standard definition for Profit Margin. Instead, the correct approach involves using net income, which reflects the company's profit after all expenses have been deducted, including operating expenses, interest, and taxes, and dividing that by total revenue, which indicates the total amount of money generated from sales before any costs or expenses are applied. Evaluating the other choices: Operating Income / Total Revenue would represent operating margin, which focuses solely on the profitability of the core business operations, excluding non-operating income and expenses. Earnings Before Interest and Taxes (EBIT) / Revenue gives a view on operational efficiency before financing costs and taxes but is not classified as the profit margin. Lastly, Net Income / Total Assets measures return on assets, a different profitability metric focused on how effectively a company uses its assets to generate profit. Thus, Profit Margin reflects the percentage of revenue that constitutes profit, and the conventional calculation is through net income divided by total revenue.