Net Profit Margin Ratio


Definition

Net Profit Margin Ratio is the percentage of net profit relative to the revenue earned during a period.

Net Profit Margin Ratio is also known as Net Profit Margin Percentage and NP Margin.

Formula

Net Profit Margin Ratio=Net Profitx100%
Revenue

Where:

  • Net Profit is equal to total income minus total expenses during a period;
  • Revenue is income earned from the principal business activities

Example

ABC PLC is a manufacturer of stationery supplies.

The financial results of ABC PLC for the year ended 30 June 20X4 are as follows:

$ Million
Income
Sales revenue from selling stationery100
Gain on disposal of investments10
Interest income on bank deposits20
130
Expenses
Production expenditure60
General and administrative expenses20
Taxation15
95
Net Profit (Income Less Expenses)35

Net Profit Margin Ratio will be calculated as follows:

NP Margin %=Net Profitx100%
Revenue
=$35x100%
$100
=35%

Explanation

Net Profit Margin Ratio indicates the proportion of sales revenue that translates into net profit. For example, a net profit margin of 35% means that every $1 sale contributes 35 cents towards the net profits of the business.

Net Profit Margin ratio is a key performance indicator of the profitability of an enterprise. It is one of the two elements that determine the return on assets, the other element being the sales turnover ratio.

Measuring the trend of NP margin over several periods in comparison to industry benchmarks is crucial for identifying performance gaps that could be overcome to improve the profitability of business in the future.

Analysis & Interpretation

NP Margin can vary significantly from business to business and can be affected by internal and external factors.

Example of factors that can affect the net profit margin are as follows:

Industries & Segments The type of industry and market segments have a major impact on the net profit margin of businesses. The competitive environment within an industry segments influence the selling price, cost of factors of production and the cost structure of businesses as discussed below.
Selling price Selling price is influenced by a number of factors such as:
  • Product differentiation
  • Bargaining power of customers
  • Number of competitors
  • Availability of substitute products and services
  • Pricing strategies
Cost of factors Cost of factors of production can vary due to several reasons such as:
  • Inflation
  • Increment in salaries, wages and benefits
  • Shortage in the supply of raw materials and labor
  • Bargaining power of suppliers
  • Availability of substitute materials
  • Replacement of fixed assets causing an increase in depreciation or amortization
  • Increase in the age of fixed assets resulting in a lower depreciation expense
Efficiency Efficiency of the operations of a business determine how many resources it consumes for a given level of output.
Efficiency could be improved in the following ways:
  • Economies of scale
  • Lean management structure (flat organizations)
  • Lower proportion of fixed costs and overheads in the organization's cost structure
  • Optimization of workflows and supply chain (e.g. JIT)
  • Minimization of waste
  • Automation
Debt to equity ratio The level of gearing directly affects the proportion of interest expense deducted from profits.
Taxation Tax expense is affected by the following factors:
  • Change in tax rates
  • Change in the applicable tax bracket
  • Tax exemptions, credits and loss adjustments
  • Group tax structure
  • Prior period adjustments
Non-recurring
gains and losses
NP Margin of specific accounting periods can be affected by non-recurring gains and losses such as:
  • Gain / Loss on disposal of fixed assets and investments
Discretionary expenditures Increase in discretionary expenditures such as research and development costs may improve future profitability at the expense however of the current period's NP margin.
Accounting policies Variations in the accounting policies used by different companies (e.g. historical cost vs. revaluation basis) can affect their respective NP margins.