When Dorothy, the Scarecrow, the Iron Man and the Cowardly Lion arrived at the Emerald City to meet the Wizard, they were desperate to find “a brain, a heart, a house and the nerve.”
Blinded by the sparkling grandeur, they didn’t stop once to think they might get ripped off. How could we give them these intangible objects?
While the billions of dollars companies make each year can wow shareholders like doe-eyed Dorothy, it’s just as important that they pay attention to expenses and taxes in addition to profits.
If we’re realist, net profit margin is a calculation every smart investor should know so they don’t go all the way to Wall Street to find that their stock has depreciated.
Net profit margin measures the income of a business after all expenses are accounted for, compared to the company’s total revenue.
Definition of net profit margin:
A percentage or decimal representing the amount of a company’s total revenue that it keeps after all costs and expenses are paid
You can think of net profit margin as the portion of every dollar in revenue that the business keeps after paying off everything else, such as interest expense, taxes, employee payments, and raw materials.
In short, the net profit margin is the total profit as a percentage of its sales.
What is a good net profit margin?
A good net profit margin, like most financial measures, varies by industry and company. You can’t compare the net profit margins of two companies in very different industries, like healthcare and food, and expect to learn nothing about how they stack up against each other.
However, if you compare two companies with similar types of expenses, you might learn something about the thoroughness of a vessel they operate. Net profit margin is a measure of efficiency and profitability. The higher the profit margin, the better. Companies looking to increase their net profit margins must find a way to cut costs while maintaining the same revenues.
How do you calculate the net profit margin?
Net profit margin is calculated using a company’s net income and total income, all data that can be found on its income statement. A company’s net income is its gross profit less cost of goods sold, or COGS. Rather than calculating it, you can always find the bottom line at the bottom of the income statement.
|Advice: Net income is also known as bottom line because it appears at the bottom of an income statement.|
Once you know the net income and revenue of a business, connect them to the equation below to find the net profit margin.
Net Profit Margin Equation
|Net profit margin = Net income / Revenue x 100|
Example of net profit margin
Let’s compare the profit margins of two similar companies to see which is the most profitable: McDonald’s and Wendy’s.
|Total income: $ 21,025,200,000|
|Net revenue: $ 5,924,300,000|
|The net profit margin = 5,924,300,000 / 21,025,200,000 x 100 = 28.18%|
|Total income: $ 1,589,936,000|
|Net revenue: 460 $ 115,000|
|The net profit margin = 460 115,000 / 1,589,936,000 x 100 = 28.94%|
Even though McDonald’s net income is much higher than Wendy’s, their net profit margins are very similar. This means that even if one business makes more money than another, it is just as profitable, and Wendy’s, the smaller of the two, has a slight edge over McDonald’s when it comes to net profit margin.
This may be because McDonald’s pays its employees higher wages or Wendy’s uses cheaper supplies. We do not know for sure by this calculation; it is most likely a combination of several factors.
Net profit margin vs gross profit margin
Net profit margin is a more accurate measure of a company’s profit margin. Gross profit margin tells you the profit margin of a business without taking into account taxes, cost price, interest, or other expenses.
Draw the curtain
Instead of getting carried away with big numbers and gross profits, a simple calculation to find a company’s net profit margin can give you a more realistic picture of how a business is doing. This is the least that investors can do to learn more about profitability. However, if you’d rather not do the math yourself, investment portfolio management software can help.