Last Updated on April 13, 2022
Net profit margin is one of many ways to measure the success and growth of your business over time. Your business’s net profit margin can inform decisions related to the profitability of your business, but it can’t tell you everything.
Read on to learn more about net profit margin, calculating it, and how it can help you grow your business.
Net Profit Margin Explained
Net profit margin is the percentage of your total revenue that you keep as profit. In other words, your net profit margin is the amount of money you make after accounting for your expenses.
Your net profit margin is the amount of your total revenue that remains after subtracting all expenses from the period. These expenses include operating costs, cost of goods, taxes, interest, and anything else your business spent money on.
How to Calculate Net Profit Margin
Net profit margin is a simple calculation that uses your total revenue and cost metrics.
Net profit margin = (revenue-cost) / revenue
Follow these steps to solve the equation:
- Calculate your total revenue and total cost in the period you are reviewing. Plug these numbers into the net profit margin calculation.
- Subtract your cost from your revenue.
- Divide the number you just calculated by your total revenue
- Convert the answer from a decimal to a percentage. Do this by multiplying by 100 or moving the decimal point two spaces to the right.
Calculate your revenue by adding the total amount of money your business generated. Calculate your cost by adding up the total amount of money your business spent.
You can usually find your revenue and cost statements listed on your business’s financial reports or other bookkeeping summaries.
An Example of a Net Profit Margin Calculation
Let’s look at an example. Say your business generated $10,000 in revenue last month but spent $7,000 in operating costs, taxes, and interests. It leaves you with the following numbers:
- Revenue = $10,000
- Cost = $7,000
Our calculation looks like this: Net profit margin = (10,000-7,000)/10,000.
Here are the steps to solve the equation:
- Net profit margin = (10,000-7,000)/10,000
- Net profit margin = 3,000/10,000
- Net profit margin = .30
- Net profit margin = 30%
Your business had a profit margin of $3000, or 30%. $3000 became 30% because 3000 is 30% of the total revenue (10,000).
How to Use Net Profit Margin to Evaluate Your Business
Net profit margin is a helpful metric in the following situations:
- Assessing the overall health of a business
- Comparing a business to its competitors
- Determining a businesses’ success over time
- Evaluating the success of initiatives to improve profitability
How to Use Net Profit Margin to Assess Your Business
Net profit margin tells you how much of your revenue is profit. It is an essential part of evaluating the health of your business and determining profit growth.
A successful and healthy business will have a high net profit margin. You might be making a significant amount of money. Still, if you spend most of it on your business costs, you might not have a sustainable business plan.
How to Use Net Profit Margin to Compare Your Business to Competitors
Net profit margin is an excellent way to compare a business to its competitors. Ideally, your business will have a higher profit margin than your competitors.
If similar businesses have a higher profit margin than you, you should consider how to reduce costs or increase revenue to keep yourself ahead of the game.
How to Use Net Profit Margin to Determine Business Success Over Time
Reviewing your net profit margin from different periods or years past can help you see if your business is becoming more successful over time. You want to see your net profit margin increasing as time goes on.
When analyzing these numbers, be sure to consider periods with unusual costs, such as opening a new location. These costs may skew your numbers for some periods but then lead to a higher profit margin in the future.
How to Use Net Profit Margin to Evaluate Profitability Initiatives
Suppose you have implemented initiatives to grow your profitability. In that case, your net profit margin is the best way to determine if your endeavors are successful.
If your net profit margin is not growing, you might want to return to the drawing board to adjust or change your strategies.
What Net Profit Margin Won’t Tell You About Your Business
Net profit margin is only one metric and cannot tell you everything you need to know about your business. Here are a few limitations to be aware of:
- Net profit margin does not help compare companies in different sectors
- One-time events easily skew the net profit margin
“Strong” net profit margin numbers vary significantly across industries and financial sectors. As a result, it will not be a helpful metric in comparing businesses that are not competitors. A strong net profit margin in one industry might be a poor one in another.
The simple calculation method of the net profit margin does not allow for adjustment based on one-time or atypical events. This aspect is a significant limitation, as a non-routine cost might completely skew your net profit margin for a single period.
For example, opening a new location will bring many costs that you do not typically have in a regular period. It can lower your profit margin, implying your business is not doing as well as it once did. However, this is not the complete picture, as that new location will likely improve your profit margin in the future.
How Do I Offset the Limitations of Net Profit Margin?
The best way to account for the limitations of net profit margin is to combine it with other metrics. Looking at many different metrics will allow you to develop a complete picture of your financial health.
Here are other metrics to use with net profit margin:
- Gross margin
- Revenue growth
- Overhead expenditures
- Change in net profit margin over time
Net Profit Margin: The Bottom Line
Net profit margin is a helpful metric to analyze the financial health of your business. Use net profit margin to evaluate your success, compare your business to competitors, analyze business growth over time, and determine if profitability initiatives are successful. Combine net profit margin with other metrics to develop a complete picture of your business performance.
Grey is the Director of Marketing for altLINE by The Southern Bank. With 10 years’ experience in digital marketing, content creation and small business operations, he helps businesses find the information they need to make informed decisions about invoice factoring and A/R financing.