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 one can use the terms 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:
Put differently, it's the ratio of net income (NI) to revenue. The above equation is most often expressed as a percentage. Normally, investors will notice that companies quote all "margin" line items as percentages on their financial statements; 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 can 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 comprises all sales, fees or other money the business has collected through the period. To determine profits, subtract operating expenses, cost of goods sold, 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 divide net profit by revenue and convert it to a percentage by multiplying 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 percent. 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 get a net income of $4.350. If Jazz Music Shop also had to pay interest and taxes, that too would have been deducted from revenues. Now, we take the ratio of net income to revenue: $4,350/6,400 x 100 = 68% net profit margin.
The Importance of Net Profit Margin
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 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.