Net Profit Margin Analysis
Gross Profit Margin Ratio Analysis
Net Profit Margin Ratio
Using the net profit margin ratio formula, though essential, is a fairly simple process. The difficulty is taking steps every day to keep the proper financial information to calculate this and other financial ratios. Use this formula as a net profit margin calculator:
Net profit margin = Net income ÷ Total revenue
Financial calculators exist which can simplify the process of net profit margin calculation.
Net Profit Margin Example
For example, Steve owns a sole proprietorship which provides tech support services for small businesses. His company, serveco, is succeeding and making Steve a living wage. Steve has recently earned as many customers he is willing to handle. He now wonders if he can increase company profits while maintaining all other aspects of his business. He has considered implementing an inexpensive system to access client’s computers online instead of visiting their office. Steve, though not a CPA, is a very competent man. He begins by searching Google for “net profit margin ratio calculator” and eventually finds the information he needs. Steve converts his company records to Quickbooks. His result is the calculation below.
Because companies come in all different shapes and sizes, it is natural to observe that their net profit margins would differ as well. In fact, businesses can have a profit margin of as high as 19% or as low as 5-10%. As one would expect, the companies with the higher net profit margin are the ones that are the best organized. The companies that are the best organized are the ones that are the most efficient. The ones with the least amount of profit margin are, by contrast, the companies that are the least organized and efficient. Though, it must be said though that the ratio can be good or bad for industry that a business is in. For example, a 10% net profit ratio could be good for one industry and bad for another.
Net Profit Margin Rule
As a general rule of thumb, businesses should strive to maintain a net profit margin ratio that is above the average for the industry a business is participating in. At the same time, the business should also try to maintain a trend with that ratio that is improving, at least slowly, over time. Furthermore, a company can maintain a low ratio by finding ways to reduces expenses.
To learn how to price for profit, download our Pricing for Profit Inspection Guide.
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