What is Net Profit Margin?
Net profit margin refers to the overall earnings or revenue left after deducting all sales expenses. This percentage determines the amount of profits a business gained from all the sales.
The net profit margin equation is = (Net profits/ Net sales) (100)
More on net profit margin
Net profit margin is also known as profit margin or net profit margin ratio. It is a financial ratio that calculates the company’s profit percentage from the total revenue. Businesses usually do this monthly, quarterly, and annually for their financial statement standard reporting.
Through net profit margins, we can determine if a business is booming. When the net profit margin is huge, it means that the pricing and control are proper. And when we say high, the net profit margin usually needs to be more than 10%. A gross profit margin works hand in hand with a net profit margin. It determines the total expenses of sales. Companies can also compare their results to any other company with the same environment and customers. In this way, companies can monitor the competition.
The downsides of net profit margin
As good as it may sound, the net profit margin also has some disadvantages that come with it. Listed below are some of them:
- Comparability. Industries might need to earn a high net profit margin to raise enough cash flow to purchase assets and capital. A low net profit margin may be acceptable sometimes because inventory changes quickly.
- Leverage. When we say leverage, we refer to debts, and debts usually come with interests that decrease net profit margin.
- Accounting standards. A company generates revenue to comply with the accounting standards that may display a wrong idea about the cash flow. High cash flows do not always mean a high net profit margin.
- Taxes. A company could have a high net profit margin if it used a net operating loss carryforward to its profit before deducting taxes. Also, a company may reduce its tax liability amount to make noncash expenses recognition quicker in its current period. Furthermore, an incident with taxes can make a significant impact on the net profit margin.
- Short-term goals. Some companies halt the opportunity to compete for a more extended period when they try to cut expenses they do not need to cut. Companies should not cut back on discretionary costs such as research and development, equipment maintenance, marketing, and more just for the sake of cutting expenses because this can halt growth.
- Items that do not operate. Large sales do not always equate to a well-off company. A company can have a net profit margin even when it strives hard to compete. A random significant non-operating gain or loss can massively impact the net profit margin.
Citing an example
X Company’s net profit for this month is $10,000. Their overall sales amount is $100,000. If we use the net profit margin formula, we will have:
($10,000 net profit/$100,000 net sales)(100) = 10% net profit margin
A net profit margin indeed can help a company know how profitable it is, but at the end of the day, there are still many factors to consider before resting assured that a company is doing fine. After all, it is just a percentage to help figure out a company’s financial health. Still, it does not give a hundred percent accuracy in telling if a company is actually successful.