Net profit margin is the profitability matrix which is used to measure how much net income a company earned from its each dollar sales.
Definition: What is Net Profit Margin Ratio?
Investors compare net income to total sales to see what percentage of revenue used for the operating and not operating expenses, and what percentage of revenue used to pay shareholders or reinvest in the company.
As compared to low margin high margin is better. Because with high margin the company can easily convert more of its sales into cash at the end of the year or period. Between the industry the margin change drastically.
Net profit margin formula can be calculated by dividing the net income by total revenue.
Net profit margin = net income/total revenue
The calculation of net profit margin is so simple because from the income statement we easily get the values and put in the above formula to calculate the NP margin. Total revenue is the money which is earned by the company through its operations during the period.
After the payment of all the expenses, leftover income during the period is called net income.
For a better understanding of the net profit margin calculation, we take the example.
Net Profit Margin Example
Under the same industry company X, Y, and Z working. The income statement of these companies shows the following report.
On the basis of net income, we can compare company X and company Y but it does not tell the profitability’s entire story. The income statement shows that company Y is more profitable than company X, and company Z.
According to income statement company, X and company Z get equal profit so these have the same profitability.
Now we take the profit in dollar amount to know the revenue generated by these companies.
Now to find the profitability of these companies separately by using the NP margin equation.
From the above result it is clear that Company X and Z has the same net profit margin whereas Company Y has 10% greater NPM then company X and Y.
Analysis and Interpretation
How do Analysts look at Net Profit Margin?
Net margin is one of the most useful measurements in financial measurement if compared to the history of the company.
Through historical analysis of any company, we analyze that the profitability of the company is increasing or decreasing. From the trend analysis, we can find the sustainability of the company. If the margin is decline then it may be due to the high competition, reduced bargaining power, or inefficient cost of the company.
We can compare the margin of those companies through the NPM equation which works under the same industry. Because different industries have different cost base.
For the understanding of the driver of margin analysts striping down the various elements of NP margin. This ratio is used to analyze its impact on the return measures such as ROE and DuPont analysis.
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