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What is 'Net Profit Margin'

Net profit margin, or net margin, is equal to net income or profits divided by total revenue and represents how much profit each dollar of sales generates. Net profit margin is the ratio of net profits or net income to revenues for a company, business segment or product. 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 collected by a company as revenue translates into profit. The term "net profits" is equivalent to "net income" on the income statement and the terms can be used interchangeably. Most commonly, investors will refer to net profit margin as the "net margin" and describe it as "net income" divided by total sales instead of using the term "net profits."

BREAKING DOWN 'Net Profit Margin'

The equation to calculate net profit margin or net margin is written as:

Net Profit Margin = Net Profit / Total Revenues

or

Net Margin = Net Income / Total Revenues

The above two equations are expressed as a percent. Normally, investors will notice that all "margin" line items in a company's financial statements will be quoted as a percent; however, profit margins may also take a decimal form when used as an input to calculations.

Most publicly traded companies report their net margins both quarterly during earnings releases and in their annual reports. Companies that are able to expand their net margins over time are generally rewarded with share price growth, as share price growth leads directly to higher levels of profitability.

How to Calculate Net Profit Margin

To calculate net profit margin, find the company's revenue, which consists of all the sales, fees or other money the business has collected through the period. To ascertain profits, subtract operating expenses, cost of goods sold (COGS), interest and tax from revenue. If the business pays stock dividends, also subtract those payments from revenue when calculating profit, but do not take common stock dividends into account. Then, simply divide net profit by revenue, and to convert that number into a percent, multiply it by 100.

To illustrate, imagine a business has $100,000 in revenue, but it also has $20,000 in operating costs, $10,000 in COGS and $14,000 in tax liability. Its net profits are $56,000. Profits divided by revenue equals 0.56 or 56%. A 56% profit margin indicates the company earns 56 cents, or $0.56, in profit for every dollar it collects.

The Importance of Net Profit Margins

Net profit margin is one of the most important indicators of a business's financial health. By tracking increases and decreases in its net profit margin, a business can assess whether or not current practices are working and forecast profits based on revenues. Additionally, because net profit margin is expressed as a percentage rather than a dollar amount, it is possible to compare the profitability of two or more businesses regardless of size.

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