Net Profit Margin

Net income divided by total revenue, expressed as a percentage.

What is Net Profit Margin?

Net Profit margin (or simply “Profit Margin”) is a ratio used to calculate the percentage of profit a company produces from its total revenue.

The profit margin ratio of each company could be different depending on which industry the company presents. As a financial analyst it’s important in day-to-day analysis.

Net Profit Margin Formula

Net Profit margin = (net income) ⁄ (total revenue)

Net income is calculated by subtracting all company expenses from its total revenue. The result of a profit margin calculation is a percentage – a  10% profit margin means for each $1 of revenue the company earns $0.10 in net income.

The Use of Net Profit Margin Ratio

The profit margin ratio is used to describe a company’s ability to produce profit and to consider several scenarios like an increase in expenses, which are deemed ineffective, and used extensively in financial modeling and company valuation.

A single number in a company report is rarely adequate to point out overall company performance; an increase in revenue might translate to a loss if followed by an increase in expense. On the other hand, a decrease in revenue, followed by tight control over expenses, might put the company in profit.

Other common margins are EBITDA and Gross Profit.

Investors need to take numbers from the profit margin ratio as an overall image of company profitability performance and initiate deeper research on the cause of an increase or decrease in the profitability as needed.

Limitation of Profit Margin Ratio

When calculating the net profit margin ratio, analysts commonly compare the different companies’ ratios to determine which company performs the best.

While this is best common practice, profit margin ratio could greatly differ between companies in different categories. For example, a company in an automotive industry may have high profit margin ratio but lower revenue compared to a company in the food industry.  A company in the food industry may have a lower profit margin ratio, but higher revenue.

It is recommended to compare only companies in the same sector that have similar business models.

Financial analysis

Calculating the net profit margin of a business is a routine part of financial analysis.

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