Multiple Choice
Which of the following statements correctly defines a profit margin?
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14. Financial Statement Analysis
Ratios: Profit Margin
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Join thousands of students who trust us to help them ace their exams!Watch the first videoMultiple Choice
Which of the following ratios will help you assess the profitability of a company? Select one.
A
Debt-to-Equity Ratio
B
Profit Margin Ratio
C
Current Ratio
D
Inventory Turnover Ratio
Verified step by step guidance1
Understand the concept of profitability: Profitability refers to a company's ability to generate earnings relative to its revenue, assets, or equity over time. Ratios that measure profitability focus on how efficiently a company generates profit.
Review the given options: Debt-to-Equity Ratio measures financial leverage, Current Ratio assesses liquidity, Inventory Turnover Ratio evaluates operational efficiency, and Profit Margin Ratio measures profitability.
Focus on the Profit Margin Ratio: This ratio is calculated as \( \text{Profit Margin Ratio} = \frac{\text{Net Income}}{\text{Net Sales}} \), and it indicates the percentage of revenue that remains as profit after all expenses are deducted.
Eliminate irrelevant ratios: Debt-to-Equity Ratio, Current Ratio, and Inventory Turnover Ratio do not directly measure profitability. They focus on other aspects like financial structure, liquidity, and efficiency.
Conclude that the Profit Margin Ratio is the correct choice for assessing profitability, as it directly evaluates how much profit a company generates from its sales.
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