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Which of the following ratios measures the proportion of sales that finds its way into profits?
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14. Financial Statement Analysis
Ratios: Profit Margin
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The profit margin is equal to net income divided by which of the following?
A
Total liabilities
B
Total assets
C
Gross profit
D
Net sales
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Understand the formula for profit margin: Profit Margin = Net Income / Net Sales.
Recognize that profit margin measures how much of each dollar of sales is converted into net income.
Eliminate incorrect options by understanding their definitions: Total liabilities and total assets are balance sheet items, not directly related to sales or income. Gross profit is a subtotal on the income statement, not the denominator for profit margin.
Identify that 'Net Sales' is the correct denominator because it represents the total revenue generated from sales after deducting returns, allowances, and discounts.
Conclude that the profit margin formula specifically uses 'Net Sales' as the denominator to assess profitability relative to revenue.
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