The net profit margin is a percentage that shows how much of a company’s revenues are kept as net income and it is part of the company’s income statement.
Net Profit Marins – It’s Strenght And Weaknesses
When investing in a company or running your own business, one of the most important metrics to look at is the net profit margins. When buying a stock or starting a business, one of the primary goals is to get a return for the investment. If you don’t know what the net profit margin, then its likely that you won’t know if a business is making money or not.
In this article, you will learn about the net profit margin, the formula, importance, and more.
The idea of a net profit margin is elementary to understand. This metric is useful for determining how much a business can extract profit from net sales. The formula for net profit margin goes like this :
(Net Profit / Net Sales ) X 100 = Net Profit Margin
Net Profit Margin Calculator
Importance Of Net Profit Margin
The net profit margin is a metric that can give you a good picture of the overall success of a company. If a company is showing a high-profit margin, it generally means that it is maximizing the sales of its products while minimizing costs. This metric is often used for regular reporting periods like monthly, quarterly, or annually. It’s typically found in the income statement.
The net profit margin is especially a good indicator when evaluating several companies within the same sector as the cost structures, customer base, and business environment are roughly the same. Hence, if business A has a higher net profit margin when compared to business B within the same sector, then its safe to assume that business A is the better company.
For most mature companies and sectors, 10% and above net profit margin is considered as excellent. However, the number could change drastically depending on the sector, business structure, and other factors.
Things To Consider About Net Profit Margins
Like all metrics, net profit margins has its own weakness. Therefore, you should not consider this as a “be-all and end-all” metric. In fact, it’s better that you consider it as an important piece of a puzzle. Below are a few things you should be aware of net profit margins.
* Comparability – the “acceptable” profit margins vary from one sector to another. In some sectors, low-profit margins are acceptable. A good example is grocery stores. Such establishments generally have low acceptable profit margins because the products move quickly. On the other hand, a high net profit margin is a must for sectors that carry slow-moving inventories. Otherwise, the business may run into the risk of not be able to stay above the fixed cost and other similar expenditures.
* Leveraged Situations – another issue with net profit margin is it’s not the complete picture of a business. Leveraged situations may give you a falsely negative view of a business. If a business chooses to grow through debt financing, it’s natural for a company to pay interest fees and such. These will then bring down the net profit margin. If you blindly believe the net profit margin metric, then you run into a risk of losing a good opportunity. For example, the business could be very healthy, but because of the current debt financing, it’s bringing the net profit margin down. By the time the debt gets paid off, the business may have an above-average net profit margin.
* Non-operating Items – another weakness of the net profit margin is it only takes into account the sales and expenditures. There are instances that a business is showing a very high net profit margin. However, it could be due to a single event that is not part of “normal business operations.” This could be a huge but unrepeatable sales order. In such cases, you may end up being tricked that the business is very profitable when, in fact, it’s a temporary spike.
Wrapping It All Up
After this article you need to read about contribution margin and how is contribution margin ratio useful in planning business operations.
The net profit margin is expressed in terms of percentage. It’s a metric that reports the percentage of profit a company can get from net sales. The net profit margin is often a metric that is used to gauge the health of a business and to compare it with other similar businesses. However, keep in mind that it’s only a piece of a puzzle, and there are instances that the net profit margin can be harmful if you blindly trust the metric.