Certified Fraud Examiner Practice

The formula for calculating gross margin is derived from the relationship between net sales and the cost of goods sold. Gross margin represents the amount remaining from net sales after accounting for the cost incurred to produce the goods sold.

By using net sales and subtracting the cost of goods sold, you arrive at gross margin, which indicates how efficiently a company is producing its goods. It reflects the amount available to cover operating expenses, taxes, and profit after the direct costs of production have been deducted. A higher gross margin indicates a more profitable product line or a company that is effectively managing production costs.

The other options do not accurately represent the calculation of gross margin. For instance, subtracting expenses or adding cost of goods sold to net sales does not provide a relevant measure for evaluating the profitability of sales after covering their direct costs. Similarly, calculating cost of goods sold as a ratio to net sales (the last option) focuses on a proportion of sales allocated to production costs rather than yielding a direct measure of gross margin. This clarity helps in understanding not only how to compute gross margin but also why it is significant in financial analysis and decision-making.