Table of contentsWhat is the net profit margin (net income margin)?The net profit margin formulaHow to calculate net profit margin?Example of the net profit marginIs there an optimal net profit margin ratio?FAQs
The net profit margin calculator allows you to work out a simple and intuitive measure of a company's profitability in relation to its total revenues. It's a straightforward way to determine how large the profit generated by a single dollar of sales is. Learn more about this in our retained earnings calculator. Business owners, investors, and shareholders generally prefer a higher net profit margin ratio (also called "net income margin"), as it indicates the overall financial health of a company and informs you if its business model is effective and sustainable.
This article will also help you to discover:
- What exactly is the net profit margin?
- How to calculate net profit margin with your data?
- What's the best value for the net profit margin ratio?
What is the net profit margin (net income margin)?
The net profit margin is one of the basic profitability ratios you can find in financial analytics. It's often used to complement well-known efficiency measures that rely on the asset or equity values. Unlike these indexes, the net profit margin compares net income to total revenue. This indicator is based on the idea that each sale a company makes translates into revenue. Revenues, in turn, are converted into income. The net profit margin formula may approximate the efficiency of this process.
However, the net profit margin is not merely the amount of cash left in the company after all costs (e.g., salaries, utilities, or depreciation) are covered. That's the gross profit margin. In order to get your hands on the net profit, you have to consider all of the operating expenses, interest expenses, and taxes.
The net profit margin formula is also a convenient way to warn you if there's something wrong with a company. If you notice a consistent downward trend in this index, maybe it's time to ask if there's something bad going on. Are expenses misdirected? Are investments unproductive? Maybe it's just poor customer service?
The net profit margin formula
The net profit margin is determined by dividing net profit by total revenues in the following way:
net profit margin = net profit / total revenues.
The result of these calculations is displayed in percentages, but you may also express them in decimal form (e.g., 13% becomes 0.13). Note that the net profit margin ratio is not the same as [profit margin of the business you're trying to analyze.
How to calculate net profit margin?
To quickly calculate the net profit margin, follow these easy steps:
Find out a company's net profit by looking at its financial statement. (Important: the data you are looking for may sometimes be found under the "net income" category.)
Get data on the net profit. Remember that
net profit = total revenues - total expenses, with total expenses including operating expenses, interest expenses, and taxes.
Take a look at the net profit margin formula above. The result of this equation is not an absolute number but rather a percentage of total revenue.
You're good to go. Employ the net profit margin formula by dividing net profit by total revenue, or - since you're here - do it using our net profit margin calculator.
Now scroll down to see how to interpret your calculations, and learn if there are proper or advisable values of the net profit margin ratio.
Once you employ the net profit margin formula, it's quite easy to compare its values over time and see what's a company's performance against the market or its main competitors.
Example of the net profit margin
Take a look at this example of the net profit margin calculation. Let's say there are three companies. They all got the same total revenue of $1,500,000 last year. This, however, doesn't say anything about their profitability. According to its cash flow statement, the net income of company A equaled $155,000. Company B earned a net income of $20,000, while Company C generated a loss of $-75,000. Note how easy it is to merge this information into one comparable indicator.
The net income margin values for each of the companies are, respectively,
155,000 / 1,500,000 = 10.3%,
20,000 / 1,500,000= 1.3%, and
-75,000 / 1,500,000 = -5.0%.
Is there an optimal net profit margin ratio?
Unless a company's profit is negative (i.e., it generates a loss), the net profit margin formula should produce a value from 0% to 100%. In practice, it's often hard to find estimates larger than 30%. You may be tempted to think that the higher your net profit margin, the better for you. Most of the time, you will be right. Keep in mind, however, that typical values of this indicator depend on the type of business you're in, as well as the overall shape of the economy. If your company faces fierce competition, your net profit margin will probably be lower compared to a situation when you're a sole supplier to the market. Consequently, the desirable values of this indicator are entirely relative. It's also a good idea to compare profitability measures to liquidity indicators, such as the current ratio, to get a broader picture of a company's financial stance. To learn more about the current ratio, visit our current ratio calculator.
Also, the net income margin of different enterprises varies significantly across industries. For example, information services in the U.S. reveal, on average, a fairly high net profit margin ratio of about 13.4%. At the same time, the shipbuilding industry is characterized by a negative value of this indicator, -1.8%. You can check outprepared by Aswath Damodaran of the Stern School of Business at New York University to see what's an average net profit margin ratio in various sectors of the U.S. economy.
Long-term trends in net profit margin are also crucial for average rates of growth in the economy. They are used to identify sectors that efficiently convert sales revenues into profits, forecast the dynamics of each sector, and assess investment opportunities. No wonder this indicator is closely followed by investors who try to adjust their portfolios and maximize returns.
On the other hand, if you want to measure not exactly net profitability or the return to equity but measure operational profitability, you can use the return in capital employed calculator. Every investor should be looking for a high ROCE among its peers and a growing ROCE.
Finally, another factor of utmost importance, aside from profitability, is the price at which you buy the investment. In order the verify if you are overpaying for a business or not, please try our discounted cash flow calculator. Remember, the less your pay for a business, the less risk you face.
How can I calculate the net profit margin?
You can calculate the net profit margin in 3 steps:
Compute the net profit.
Determine the total revenue.
Apply the net profit margin formula:
net profit margin = net profit / total revenue
Can net profit margin be negative?
Yes, the net profit margin can be negative. A negative net profit margin indicates that a company's expenses and costs exceed its revenue, resulting in a net loss. This situation may raise concerns about the company's financial viability and profitability.
What factors can affect the net profit margin of a business?
Several factors can impact the net profit margin. These include the cost of production, pricing strategies, competition, operating expenses, taxes, interest rates, and economic conditions. Changes in any of these factors can influence a company's net profit margin.
What is the net profit margin if the net profit is half of the total revenue?
The net profit margin will be
50%. You can calculate it using this formula:
net profit margin = net profit / total revenue.
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