What is the Net Profit Ratio?
The net profit ratio is the net income of the business expressed as a percentage of the revenue, and is a measure of the overall profitability of a business. It is calculated by dividing net income by revenue. The ratio is also called Net Margin or Net Profit Margin.
Formula for Net Profit Ratio
The net profit ratio is calculated using the formula shown below.
- Net income is found in the income statement.
- Revenue is also found in the income statement. It may be called Sales or Turnover.
How do you calculate Net Profit Margin?
|Cost of sales||17,600|
|Income before tax||4,400|
|Income tax expense||900|
In the example above the net income is 3,500 and the revenue is 44,000. The net profit ratio is given by using the formula as follows:
Net profit ratio = Net income / Revenue Net profit ratio = 3,500 / 44,000 = 7.95%.
What does the Net Profit Ratio show?
The net profit margin ratio shows what percentage of the revenue is left after deducting all costs. The higher the net profit margin ratio the more profit the business earns on its revenue.
Useful tips for using the Net Profit Ratio
- The net profit ratio will vary from industry to industry, so it is important to make comparisons to similar businesses in your sector. If your net profit ratio is substantially different from other businesses within your sector it will need investigation to ascertain why.
- The aim is to get the net profit ratio as high as possible.
- One off items should be excluded from both revenue and net income, as the net profit margin ratio is a measure of the operating performance of the business.
About the Author
Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a BSc from Loughborough University.