What is a Net Profit Margin?

The net profit margin is a figure that identifies how much profit is left after all taxes and other expenses related to the operation of the business have been settled. There are several approaches used to calculate this type of margin, with most methods being only slight variations off one central strategy. Calculating the net profit margin is considered important, as this figure represents the true profit generated by the business during the period under consideration.

Determining the percentage of net profit margin usually involves the simple formula of dividing the after-tax net profit by the amount of the sales generated during the same period. This is the most common approach, and is generally considered an accurate manner of determining the true margin. There are instances where the company may choose to also include any interest paid to the owners of the business in the calculation as well. The important point is to always use the same formula, making it easy to compare the margin from one period to the next.

Because the net profit margin is expressed in terms of a percentage, it helps the company to have a good idea of how it is managing in comparison to competitors, even though their actual sales volume may be different. For example, if a company generates sales of $50,000 in US Dollars (USD) during a particular period, and has a net profit margin of 12 percent, this translates into pure profit of $6,000.00 USD. By comparison, a competitor with sales of $75,000.00 USD and a net profit margin of 8 percent would also post a pure profit of $6,000.00 USD. From the perspective of market performance, both companies are on a par when it comes to net profits, even though their sales volumes and net profit margins are different.

For the most part, a company will strive to have the highest net profit margin possible. This means finding ways to manufacture goods and services for sale for the lowest possible cost, while still maintaining the quality that will attract customers and result in actual sales. Other factors within the operation can also be considered, such as expenses related to sales and marketing efforts, transportation of finished goods to customers, and any other expense that is related to the production of the products. Calculating the net profit margin helps a business see how well they are doing with the resources on hand, and allows them the chance to make changes if they notice that the margin is beginning to decrease.