Certified Valuation Analyst (CVA) Practice Exam

What is the purpose of including cost of sales in financial analyses?

1. To determine net income

2. To assess gross profit margin

3. To establish operating income

4. To calculate earnings per share

The correct answer is: To assess gross profit margin

Including the cost of sales in financial analyses serves the primary purpose of assessing the gross profit margin. Gross profit margin is a crucial financial metric that measures the relationship between revenue and the cost of goods sold (COGS). It indicates how efficiently a company is producing and selling its products. When analyzing financial performance, the gross profit margin is calculated by subtracting the cost of sales from total revenue and then dividing that figure by total revenue. This calculation highlights the proportion of revenue that exceeds the cost of goods sold, which is essential for understanding the profitability of core business operations. A higher gross profit margin signifies better efficiency, indicating that a company retains more earnings from its sales after covering its direct costs. While cost of sales also plays a role in determining net income, establishing operating income, and calculating earnings per share, these aspects hinge on the initial evaluation of gross profit. Therefore, the inclusion of cost of sales is fundamentally focused on its impact on gross profit margin, making it a key component in that assessment.