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Net Profit Margin

Net Profit Margin - a ratio indicating firm’s profitability through measuring the amount of the net income (company’s revenue, excluding operating expenses, interest, taxes and preferred stock dividends) generated by a dollar of sales. The indicator can be computed by dividing the company’s net earnings by its net sales. The value of this ratio measures the share of the company’s earnings that remains after excluding all expenses. It also allows to forecast the growth of the net profit if the sales volume grows by a dollar.

Analysts do not set the range of normative values for this ratio. As with many other ratios, it should be compared with competitors working in the same segment to make some conclusions. A list of the net profit margin normative values for different industries looks like below:

Indicator Agricultural production Oil and Gas Extraction Electric Power Generation, Transmission and Distribution Construction of Buildings Miscellaneous Store Retailers Religious, Grantmaking, Civic and Professional Organizations
Accounts Receivable Turnover (Times) >= 2,9 >= 18,3 - >= 4,9 >= 5 >= 1

Source: Almanac of Business and Industrial Financial Ratios

Negative net profit margin values mean that the company is degrading, while high values witness a strong position on market, high value of goods or services produced by the firm, quality management, etc.

Resolving the problems with the net profit margin exceeding the normative range:

Considering the fact that the net profit is being formed under the influence of all factors that form the company's income and expenses, the increase of the net profit margin is possible through operational, finance and investing areas. For example, some of the tools for increasing the net profit margin are:

  • Optimization of the finance structure and declining the cost of the funds involvement;
  • Usage of the tax expenditures;
  • Declining the cost of production for goods and services;
  • Optimization of the marketing communications expenses, etc.

Formula(s):

Net Profit Margin = Net Income Before Noncontrolling Interest, Equity Income and Nonrecurring Items ÷ Net Sales

Net Profit Margin = Net earnings ÷ Net sales

Example:


Net Profit Margin (Year 1) = 352 ÷ 3351= 0,10

Net Profit Margin (Year 2) = 853 ÷ 3854 = 0,22

Conclusion:

Net Profit margin was 0,10 in year 1. In year 2 it increased to 0,22, indicating that the firm has become better in terms of profitability. Net income, generated by 1 dollar of sales has increased from $0,10 to $0,22 in year 2 comparing to year 1.

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