See Also:
Gross Profit Margin
Opportunity Profit Margin Ratio
Margin vs Markup
What is Profitability Index
Download ToolNet Profit Margin Definition
The net profit margin, also known as net margin, indicates how much
net income a company makes with total sales achieved. A higher net profit margin means that a company is more efficient at converting sales into actual profit. Net profit margin analysis is not the same as
gross profit margin. Under gross profit,
fixed costs are excluded from calculation. With net profit margin ratio all costs are included to find the final benefit of the income of a business. Similar terms used to describe net profit margins include net margin, net profit, net profit ratio, net profit margin percentage, and more. To calculate net profit margin and provide net profit margin ratio analysis requires skills ranging from those of a small business owner to an experienced CFO. This depends on the size and complexity of the company.
Net Profit Margin Formula
Using the net profit margin ratio formula, though essential, is a fairly simple process. The difficulty is taking steps every day to keep the proper financial information to calculate this and other
financial ratios. Use this formula as a net profit margin calculator:
Net profit margin = Net income ÷ Total revenue
Financial calculators exist which can simplify the process of net profit margin calculation.
Net Profit Margin Example
Steve owns a sole proprietorship which provides tech support services for small businesses. His company, serveco, is succeeding and making Steve a living wage. Steve has recently earned as many customers he is willing to handle. He now wonders if he can increase company profits while maintaining all other aspects of his business. He has considered implementing an inexpensive system to access client's computers online instead of visiting their office. Steve, though not a CPA, is a very competent man. He begins by searching Google for "net profit margin ratio calculator" and eventually finds the information he needs. Steve converts his company records to Quickbooks. His result is the calculation below.
Net Profit Margin Calculation
Example: a company has $200,000 in sales and $50,000 in monthly net income.
Net profit margin = $50,000 / $200,000 = 25%
This means that a company has $0.25 of net income for every dollar of sales.
Steve has $200,000 worth of sales yet his net income is only $50,000. By decreasing costs he can increase net income. He evaluates his decision and decides to implement the online system he was thinking about.
Applications
Net margin measures how successful a company has been at the business of marking a profit on each dollar sales. It is one of the most essential financial ratios. Net margin includes all the factors that influence profitability whether under management control or not. The higher the ratio, the more effective a company is at cost control. Compared with industry average, it tells investors how well the management and operations of a company are performing against its competitors. Compared with different industries, it tells investors which industries are relatively more profitable than others. Net profit margin analysis is also used among many common methods for business valuation.
Resources
For statistical information about industry financial ratios, please go to the following websites:
www.bizstats.com and
www.valueline.com.