What Is an After-Tax Profit Margin?
An after-tax profit margin is a financial performance ratio calculated by dividing net income by net sales. A company's after-tax profit margin is significant because it shows how well a company controls its costs. The after-tax profit margin is the same as the net profit margin.
Understanding Profit Margin
- After-tax profit margin is the same as the net profit margin, which is net income divided by net sales.
- A higher margin tends to mean a company runs efficiently, but a low after-tax profit margin doesn't necessarily mean the company isn't controlling costs well. The ratio should be used with other financial measures to get a clearer picture.
- The pre-tax profit margin can be useful when dealing with companies of different sizes and scale, or tax rates. The idea that income tax payments have little bearing on the efficiency of a company.
How an After-Tax Profit Margin Works
A high after-tax profit margin generally indicates that a company runs efficiently, providing more value in the form of profits to shareholders. The after-tax profit margin alone is not an exact measure of a company's performance or determinant of the effectiveness of its cost control measures. However, with other performance measures, it can accurately depict the overall health of a company.
This financial measure communicates how much income is earned per dollar of sales. Some industries inevitably have considerable costs. As a result, their margins may be low. However, that does not equate to poor control of costs.
Requirements of an After-Tax Profit Margin
In business, net income is the total income with the removal of taxes, expenses, and the costs of goods sold (COGS). It is often referred to as the bottom line because it is the last or bottom line item on an income statement. Expenses include wages, rent, advertising, insurance, etc. Costs of goods sold are the costs associated with the production of products. Such costs include, but are not exclusive to, raw materials, labor, and overhead.
Net sales, the other component for calculating after-tax profit margins, is the total amount of gross sales with the removal of returns, allowances, and discounts. Also factored in net sales are deductions for damaged, stolen, and missing products. The net sale is a good indicator of what a company expects to receive in sales for future periods. It is an essential factor in forecasting, and it can help identify inefficiencies in loss prevention.
Example of an After-Tax Profit Margin
Company A has a net income of $200,000 and $300,000 in sales revenue. Its after-tax profit margin is 66% ($200,000 ÷ $300,000). The following year, the company's net income increased to $300,000 and its sales revenues increase to $500,000. The new after-tax profit margin is 60%.
When the growth of net income is disproportionate to sales growth, the after-tax profit margin will change. In this case, it has decreased. To an investor or analyst, it appears that costs are not well controlled. Typically, this is an indicator that variable values are not well controlled.
In the first case, the company earns $0.66 in profit for every dollar it receives in revenue. However, in the second case, it makes only $0.60 of profit for every dollar of revenue. To understand after-tax profit margins, you have to understand both net revenue and net profit.
After-Tax Profit Margin vs. Pre-Tax Profit Margin
The after-tax profit margin is the net profit margin. The pre-tax profit margin is similar, except it excludes income tax. The pre-tax profit margin is useful when comparing companies that have meaningfully different tax rates, such as those of different sizes and scale, or those operating in different countries and tax jurisdictions.
As well, comparing the same company over a time period can be more useful with a pre-tax profit margin, especially if there's been a varying tax rate or tax penalties. The idea of using the pre-tax profit margin is that tax payments have little bearing on the efficiency of a company.