What Is Net Profit Margin?
The net profit margin, or simply net margin, is equal to how much net income or profit is generated as a percentage of revenue. Net profit margin is the ratio of net profits to revenues for a company or business segment. Net profit margin is typically expressed as a percentage but can also be represented in decimal form. The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit.
- Net profit margin measures how much net income is generated as a percentage of revenues received.
- Net profit margin helps investors assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained.
- Net profit margin is one of the most important indicators of a company's overall financial health.
Formula and Calculation for Net Profit Margin
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- On the income statement, subtract the cost of goods sold (COGS), operating expenses, other expenses, interest (on debt), and taxes owed on revenue.
- Divide the result by revenue.
- Convert the figure to a percentage by multiplying it by 100.
- Alternatively, locate net income from the bottom line of the income statement and divide the figure by revenue. Convert the figure to a percentage by multiplying it by 100.
What Does Net Profit Margin Tell You?
The net profit margin factors in all business activities including:
- Total revenue
- All outgoing cash flow
- Additional income streams
- COGS and other operational expenses
- Debt payments including interest paid
- Investment income and income from secondary operations
- One-time payments for unusual events such as lawsuits and taxes
Net profit margin is one of the most important indicators of a company's financial health. By tracking increases and decreases in its net profit margin, a company can assess whether current practices are working and forecast profits based on revenues. Because companies express net profit margin as a percentage rather than a dollar amount, it is possible to compare the profitability of two or more businesses regardless of size.
Investors can assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained. For example, a company can have growing revenue, but if its operating costs are increasing at a faster rate than revenue, its net profit margin will shrink. Ideally, investors want to see a track record of expanding margins meaning that net profit margin is rising over time.
Most publicly traded companies report their net profit margins both quarterly during earnings releases and in their annual reports. Companies that can expand their net margins over time are generally rewarded with share price growth, as share price growth is typically highly correlated with earnings growth.
Net Margin vs. Gross Profit Margin
Gross profit margin is the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). COGS are raw materials and expenses associated directly with the creation of the company's primary product, not including overhead costs such as rent, utilities, freight, or payroll.
Gross profit margin is the gross profit divided by total revenue and is the percentage of income retained as profit after accounting for the cost of goods. Gross margin is helpful in determining how much profit is generated from the production of a company's goods because it excludes other items such as overhead from the corporate office, taxes, and interest on a debt.
Net profit margin is the percentage of profit generated from revenue after accounting for all expenses, costs, and cash flow items.
Limitations of Net Profit Margin
Net profit margin can be influenced by one-off items like the sale of an asset, which would temporarily boost profits. Net profit margin doesn't hone in on sales or revenue growth, nor does it provide insight as to whether management is managing its production costs.
It's best to utilize several ratios and financial metrics when analyzing a company. Net profit margin is typically used in financial analysis, along with gross profit margin and operating profit margin.
Imagine a company that has the following numbers reported on its income statement:
- Revenue: $100,000
- Operating costs: $20,000
- COGS or cost of goods sold: $10,000
- Tax liability: $14,000
- Net profits: $56,000
Net profit margin is thus 0.56 or 56% ($56,000/$100,000) x 100. A 56 percent profit margin indicates the company earns 56 cents in profit for every dollar it collects.
Let's take another hypothetical example using the made-up Jazz Music Shop's FY 2025 income statement.
Here, we can gather all of the information we need to plug into the net profit margin equation. We take our total revenue of $6,400 and deduct variable costs of $1,700 as well as fixed costs of $350 to arrive at a net income of $4,350 for the period. If Jazz Music Shop also had to pay interest and taxes, that too would have been deducted from revenues.
The net profit margin is calculated by taking the ratio of net income to revenue. Net profit margin is calculated as follows:
- $4,350 / $6,400 x 100 = .68 x 100 = 68%
Real World Example
- Net sales or revenue was $84.310 billion (highlighted in blue).
- Net income was $19.965 billion for the period (highlighted in green).
- Apple's net profit margin is calculated by dividing its net income of $19.965 billion by its total net sales of $84.310 billion. Total net sales are used as the top line for companies that have experience customer returns of their merchandise, which are deducted from total revenue.
- Apple's net profit margin was 23% or ($19.965 billion ÷ $84.310 billion) x 100.
A net profit margin of 23% means that for every dollar generated by Apple in sales, the company kept $0.23 as profit.
Source: Apple, Inc.
Frequently Asked Questions
Why is net profit margin important?
Net margin is perhaps the most important measure of a company's overall profitability. It is the ratio of net profits to revenues for a company or business segment. Expressed as a percentage, the net profit margin shows how much profit is generated from every $1 in sales, after accounting for all business expenses involved in earning those revenues. Larger profit margins mean that more of every dollar in sales is kept as profit.
How can companies improve their net profit margin?
When a company's net margin exceeds the average for its industry, it is said to have a competitive advantage, meaning it is more successful than other companies that have similar operations. While the average net margin for different industries varies widely, businesses can gain a competitive advantage in general by increasing sales or reducing expenses (or both). Boosting sales, however, often involves spending more money to do so, which equals greater costs. Cutting too many costs can also lead to undesirable outcomes, including losing skilled workers, shifting to inferior materials, or other losses in quality. Cutting advertising budgets may also harm sales.
To reduce the cost of production without sacrificing quality, the best option for many businesses is expansion. Economies of scale refer to the idea that larger companies tend to be more profitable. A large business's increased level of production means that the cost of each item is reduced in several ways. Raw materials purchased in bulk are often discounted by wholesalers.
How is net margin different from other profit margin measures?
Net profit margin takes into account all costs involved in a sale, making it the most comprehensive and conservative measure of profitability. Gross margin, on the other hand, simply looks at the costs of goods sold (COGS) and ignores things like overhead, fixed costs, interest expenses, and taxes. Operating margin further takes into account all operating costs but still excludes any non-operating costs.
What are some high and low profit margin industries?
High profit margin sectors typically include those in the services industry, as there are fewer assets involved in production than an assembly line. Similarly, software or gaming companies may invest initially while developing a particular software/game and cash in big later by simply selling millions of copies with very little expenses. Luxury goods and high-end accessories often operate on high profit potential and low sales.
Operations-intensive businesses like transportation which may have to deal with fluctuating fuel prices, drivers’ perks and retention, and vehicle maintenance usually have lower profit margins. Agriculture-based ventures usually have low profit margins owing to weather uncertainty, high inventory, operational overheads, need for farming and storage space, and resource-intensive activities. Automobiles also have low profit margins, as profits and sales are limited by intense competition, uncertain consumer demand, and high operational expenses involved in developing dealership networks and logistics.