Calculating your company's net profit margin can help paint a better picture of your business's financial health. How much revenue comes out as profit for the company can help your business grow or even evaluate potential investments. This is why we've compiled this short guide on calculating the net profit margin.
Net profit margin - explained
The net profit margin identifies the percentage of revenue that your business turns into actual profit. This can be a conclusive piece of information on your company's financial health. Considering all business activities, the net profit margin can act as a great foundation for an analysis of areas for improvement and forecasts forecast on profits based on revenues.
How to calculate net profit margin
The formula for calculating the net profit margin is as follows: Net Profit Margin = (Net Profit / Revenue) x 100. This, of course, requires you to first calculate the net profit of your company. The formula for this is as follows: Net Profit = Revenue – COGS (Cost of Goods Sold) – Operating Expenses – Interest – Taxes.
Company X makes c. GPB 50,000 in sales, however, GPB 10,000 are production costs. Also, Company X's operating costs, incl. taxes and interests, amount to GPB 6,000. Let’s look at an example to see how to work out the net profit margin in the real world. Imagine Company A makes around $100,000 in sales. However, it cost $40,000 to produce the goods, while Company A also spent a total of $15,000 on operating costs, including taxes and interest. You could work out the net profit margin formula as follows:
The formula for the net profit margin is as follows: NPM = (50,000 – 10,000 – 6,000) / 50,000 = 0.68 x 100 = 68%.
Company X has a net profit margin of 68% - 68% of the value of all their sales is profit.
Gross profit margin
The gross profit margin measures the proportion of revenue left after the cost of goods and services (COGS) has been deducted. However, this does not account for operating expenses, taxes, and interest payments. This is why the net profit margin gives you a more accurate picture.
Disadvantages of the net profit margin
The net profit margin calculation is a good indicator of a company's actual net income and profitability. However, there are some disadvantages to net profit margins as metrics. Firstly, the net margin can be influenced by one-off sales making the business's financial health seem better than it is. It can also be hard for companies across sectors to be compared using a net profit margin as the business models might differ too much. And lastly, your net profit margin shows no additional insights into eg revenue growth or breakdowns of eg production costs.