Net profit margin is the percentage of actual income that remains from its total revenue after expenses are subtracted. Looking at this can help you understand how well a company or project can generate a profit. It provides a good appraisal of how well they can balance their pricing and expenses to keep money in their pocket at the end of the sales period.
When it comes to evaluating a company’s overall health, its total income from sales can be a very misleading number. While companies have a wide range of expense costs that vary from business to business and industry to industry, their actual income is directly affected by those expenses and operating costs.
To understand net profit margin, you first need to understand the net profit and how to calculate it. Typically found on an income statement, the net profit is simply the total amount of income after expenses. The net profit looks at an amount in cash, while the net profit margin is expressed as a percentage.
Net Profit Margin Formula
This formula assumes that your variables are all taken from the same time period. So if you were looking for your net profit margin within a certain quarter, the information from your total revenue and net profit should come from that quarter as well.
It also depends on the fact that you would have the net profit already calculated. A company should have this listed on its income sheet. However, you may not have that information at your fingertips when you are doing your calculation. This might be especially true for small businesses that may not have a good handle on their accounting just yet.
If you don’t have it, you would simply take the total income for a product and subtract the expenses. To calculate the expenses from the products you have sold, you can simply multiply the cost per item by the number of sales in that period.
Your expenses would include operating costs as well. Operating costs are expenses that are accrued through day-to-day operations in a company. This might include rent, payroll, or equipment. While these may not seem to have a direct impact on the income from the sales of your products, they still affect the revenue your company maintains at the end of the day.
Net Profit Margin Example
Jean started a business where she sells handcrafted wooden play gyms for babies. Last year, she sold 5,000 at $42 apiece. Her total cost per piece is $18. Her business had $5,000 in operating expenses and paid $60,000 in income taxes. What was her net profit margin?
First, we can calculate the total cost of her product materials by multiplying them by the number of sales, coming to $90,000 in product expenses. To find the net profit amount, we would subtract her total expenses (155,000) from her revenue (210,000), coming to $55,000. Now we can break it down to identify the meaning and value of the different variables in this problem.
- Revenue: 210,000
- Net Profit: 55,000
We can apply the values to our variables and calculate the net profit margin.
In this case, Jean’s business would have a Net Profit Margin of 26.19%.
Through the use of this formula, Jean can now see the financial viability of her company. While she may have slightly higher expenses for a toy, the market seems to be accepting it well since her profit margin is extremely high. She can now look at the information as she considers cutting costs or even increasing prices.
Or, she could look at potentially increasing costs in order to increase growth. For example, she could look at purchasing new machinery or additional employees. She would need to plan for these expenses to increase the number of wooden play gyms she could produce. With enough market demand, this could generate more sales and a higher income.
Net Profit Margin Analysis
The net profit margin can be a good indication of a company’s performance. However, it is not the be-all-end-all. Just because a business has a lower net profit margin doesn’t necessarily mean that they are doing poorly. In some instances, they may even be doing better than other businesses with a higher profit margin. How is this possible?
Simply put, they sell more. If a company sells enough goods or services, they have the potential to make more than a company with a lower margin that sells less. As an example, let’s say a discount brand store has a profit margin of 3%, while a high-end retailer produces a net profit margin of 8%. While the margin is greater, the high-end store is likely to sell significantly fewer products as they are specialty store. As a result, the discount brand will generate greater sales overall.
To understand the success of a company, you can look at other calculations like the EBITDA margin, the operating margin, the pre-tax margin, and the gross margin. Using these formulas can be especially helpful for those looking to invest. If you have a good understanding of how the company has performed in the past, its track record can help you to project how it will perform in the coming months and years.
Net Profit Margin Conclusion
- The net profit margin is the percentage of the actual income that remains from its total revenue after expenses are subtracted.
- The net profit margin is used to understand how well a company can generate an income while balancing its pricing and expenses.
- The formula for net profit margin relies on two variables: the net profit and the Total Revenue.
- This formula assumes that your variables are all taken from the same time period.
Net Profit Margin Calculator
You can use the net profit margin calculator below to quickly determine a company’s ratio of profits after expenses by entering the required numbers.
FAQs
1. What is the net profit margin?
Net profit margin is the percentage of the actual income that remains from its total revenue after expenses are subtracted. This can help business owners understand how well they are doing in terms of generating income while keeping their expenses low.
2. How is the net profit margin calculated?
The net profit margin is calculated by dividing the net profit by the total revenue. This will give you the percentage of how much of the income is left over after all expenses are paid. The formula for net profit margin is:
Net Profit Margin = Net Profit / Total Revenue
3. Why is the net profit margin important?
The net profit margin is important because it can help business owners understand how well they are doing in terms of generating income. Additionally, it can help them make better decisions about their pricing and expenses. Let's say a toy maker has a high net profit margin. This means that the toy maker is able to sell their toys at a higher price than their expenses. If the toy maker experiences a decrease in sales, they may need to lower their prices to continue making a profit. However, if the toy maker experiences an increase in sales, they may be able to maintain their prices and still make a profit.
4. What are the limitations to net profit margin?
The limitations to net profit margin are that it does not consider a company's total expenses. Additionally, it does not always accurately reflect a company's performance. For example, a company may have a low net profit margin, but it may be selling a high volume of products. As a result, they may be doing better than another company with a high net profit margin.
5. How can a company improve its net profit margin?
A company can improve its net profit margin by increasing its sales or decreasing its expenses. Additionally, they may want to investigate becoming more efficient in their operations. This could help them to save money and increase their profits.
