Net Profit Margin: How to Calculate Net Profit Margin

Net profit margin is the ratio of a company's net profit (also called net income, net earnings, or bottom line) to its total revenue. This profitability ratio shows what percentage of every dollar of sales becomes profit.

For example, a company making a 45-percent net profit margin earns 45 cents of profit for each dollar of sales revenue. Net profit margin is a useful indicator of a company's overall profitability and financial health. The metric helps to determine whether or not a company has efficient operating costs and if the company is earning enough profit from its sales revenue.

Net profit margin takes into account all of a company's expenses and revenue, making it a crucial profitability metric for several reasons:

1. 1. It helps assess costs and pricing. A higher net profit margin tends to indicate that a company has an effective pricing strategy, is keeping expenses low, or a combination of both. A lower profit margin signals to company management that they should evaluate their costs and pricing strategy to increase profitability.
2. 2. Lenders use it to evaluate risk. Banks and lenders look at a company's net profit margin to assess whether or not they should grant the company a loan. Banks are more willing to give loans to a company with a high profit margin because it signifies the company likely has strong cash flow and a higher probability of paying back the loan.
3. 3. It allows for comparison between companies. Since net profit margin is a percentage of a company's revenue, you can use the metric when comparing companies of varying sizes, from small businesses to large conglomerates, in the same industry.

To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100, as seen in the following net profit margin formula:

To ensure that your calculation is accurate, adhere to these steps:

1. 1. Identify your net income. Look for the net income figure listed on the bottom line of your company's income statement. If you need to calculate the net income, simply subtract all business expenses from total revenue. These expenses include cost of goods sold (the direct cost of the raw materials and labor used to produce goods), operating expenses, income taxes, interest expenses on loans and debt, depreciation of fixed assets, and SG&A (selling, general, and administrative expenses).
2. 2. Identify your total revenue. In the net profit margin calculation, total revenue includes the amount of money earned from product sales in addition to income from other places, such as investments. Though it's not as common, some companies may substitute net sales in place of total revenue. Net sales is similar to total revenue, except it deducts the price of refunded or returned sales, allowances, and discounts.
3. 3. Organize the data by accounting period. When you identify your net income and total revenue, remember that this metric shows a company's profitability during a specific accounting period. If you use net income from the last six months, you must also use total revenue from the last six months as well.
4. 4. Plug figures into the formula. Divide your net income by total revenue and multiply the answer by 100.

There are different financial metrics you can use to track your company's health and compose your company's financial statements:

1. 1. Gross profit margin: This profitability ratio is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
2. 2. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
3. 3. Net income: Calculate the net income metric by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company. Net income is also called net profit, net earnings, or bottom line.
4. 4. Operating profit: To calculate operating profit or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.
5. 5. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.

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