CPIM Practice Exam

What is the correct formula for calculating gross margin?

1. Revenue - Total Expenses

2. Revenue - Cost of Goods Sold

3. Net Income - Cost of Goods Sold

4. Revenue - Operating Expenses

The correct answer is: Revenue - Cost of Goods Sold

The formula for calculating gross margin is indeed Revenue minus Cost of Goods Sold (COGS). This measure reflects how efficiently a company produces its goods, by showing the difference between sales revenue and the costs directly associated with producing those goods. Gross margin focuses specifically on the production costs, excluding other expenses such as operating expenses, administrative costs, taxes, and interest, which are not directly tied to production. Understanding this concept is crucial because gross margin is a key indicator of a company's financial health and operational efficiency. A higher gross margin percentage indicates that a company retains more revenue from each dollar of sales to cover its other expenses, ultimately affecting profitability. In contrast, other options involve calculations that either account for all expenses or include non-related costs, which do not accurately reflect the gross margin. For instance, subtracting total expenses would consider all operational costs, while calculating net income minus COGS would not yield a measure relevant to gross margin. Thus, the focus on COGS in option B makes it the appropriate formula for determining the gross margin.