The net profit margin is used to find out whether a business is poorly managed and to see future profitability. By comparing the total sales and the net income, the management can determine how much of the revenue goes towards expenses and how much remains for the company’s future investments.
You should know that these margins could fluctuate from business to business, but that does not mean that one company is not as profitable as another.
Net Profit Margin Formula
To get the result, you must divide the Net Income to Total Revenue, so the calculation should look like this:
The total sales or total revenue includes all the cash that the company has generated through its operations in a certain period. At the same time, the net income refers to all the cash that has been left after all the expenses have been dealt with. You can find it on the income statement, at the bottom. For this reason, it’s usually referred to as “the bottom line”.
Understanding and using the Net Profit Margin
As almost all financial measurements, the net profit margin formula is used also to predict certain aspects of the company by evaluating the company’s history. The analysts spend plenty of time stripping down elements from the net margin ratio to get a better understanding of the margin itself. Analysts themselves state that this ratio is the most important when it comes to determining the management’s efficiency.
A higher margin is much better than a lower one and it means that the company gets to transform more of its sales into pure profit. For example, retailing industries have a lower margin than any other industry, but that does not mean the end. It is more profitable to get into a retailing business because they usually make up for lost time and money much more quickly than other businesses.
Because not every calculation gives you the bird’s eye view of the whole situation, it does have some limitations. The NPM does not give you the proper view of the operating profitability of the firm. This is because it considers the interest payment and the tax shield from interest payment. There are also some aspects that could drastically affect the net income. To prevent that, some analysts just recalculate the adjusted net profit.
This margin shows how profitable a company is and the formula considers all the operating and financing expenses of the firm in its daily operations.
So, as already stated, the net profit margin is used widely by all analysts to assess a company’s profitability year by year. This calculation is made at the end of every year to see what amount of money gets in the profit box and how much gets in the expense box. In other words, it is a very simple formula that shows exactly what amount of cash turns up as profit.