What is Net Profit Margin?
Net profit margin is a profitability ratio that calculates how much percentage of the company’s earnings is left after deducting all the operating and non operating expenses (also called net profit) in a given quarter/year.
Net Profit Margin Formula
Let’s have a look at the formula below –
Net Profit Margin = Net Profit / Net sales * 100
Here we have taken “net profit” as numerator because we want to focus on “net profit.” And we are dividing “net profit” by “net sales” because we are finding the proportion of “net profit” to “net sales.”
For example, if we have a net profit of $10 and the net sales are $100; then the net margin would be = ($10 / $100 * 100) = 10%.
- To find out the “net profit,” every investor needs to look at the income statement of a company. At the end of the income statement, the investor will find the “net profit.”
- And to find the “net sales,” you also need to look at the income statement. To find out the “net sales,” we need to deduct any sales discount or sales return from the gross sales.
Example of Net Profit Margin Formula
Let’s take the examples to illustrate this.
Uno Company has the following information –
- Gross Sales – $250,000
- Sales Return – $5000
- Net Profit for the year – $30,000
Find out the net margin of Uno Company.
- We know the gross sales, i.e., $250,000.
- The sales return is $5000.
- The net salesThe Net SalesNet sales is the revenue earned by a company from the sale of its goods or services, and it is calculated by deducting returns, allowances, and other discounts from the company's gross sales. is = (Gross Sales – Sales Return) = ($250,000 – $5000) = $245,000.
- The net profit is also given, i.e., $30,000.
Using the formula of net margin, we get –
- Net Margin Formula = Net Profit / Net Sales * 100
- Or, Net Margin = $30,000 / $245,000 * 100 = 12.25%.
From this example, we find that the net margin of Uno Company is 12.25%. If we compare this net margin with the net margin of companies under a similar industry, we will be able to make an interpretation of whether the net margin of Uno Company is good enough.
Below is the snapshot of Colgate’s Income Statement from 2007 to 2015.
- Net margin is calculated for Colgate by dividing Net Profit by Sales.
- We note that Net Margin for Colgate has been in the range of 12.5% – 15%.
- However, it decreased substantially in 2015 to 8.6%, primarily due to CP Venezuela Accounting changes.
How is this Ratio useful to Investors?
- By using the net margin formula, the investors are able to understand how much a firm has been profiting from its revenue.
- If the proportion of net profit is less compared to the net sales of the company, then the investors would enquire why it is so and may find other important details about the company.
- Similarly, if the net margin is too much, then also the investors need to see through other details to find out why the net margin is too good to be true.
- Plus, if they know the net margin formula, it also tells them how much net profit a firm can extract out of their net revenue.
- However, if the investors think that the net profit would increase proportionately along with the net sales, the idea is false; because there can be expenses that are long-term and will serve the company for a long period of time and as a result, maybe the net profit would shrink. That’s why it is important to look at all of the figures before ever judging the performance of a company only through this formula.
Net Profit Margin Calculator
You can use the following calculator.
|Net Profit Margin Formula ==||
Calculate Net Profit Margin in Excel
You can easily calculate this ratio in the template provided.
Net Profit Margin – Video
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