# Net Profit Margin Ratio

The net profit margin ratio, or profit margin ratio, is a financial metric gauging a company's profitability. It's determined by dividing the company's net profit by its total revenue and multiplying the outcome by 100%.
Net Profit Margin Ratio
3 min
30-August-2024
The net profit margin ratio is a measure of the net income of the business or the profit generated expressed as a percentage of the revenue. This financial ratio measures the net profit of a company per rupee of revenue it generates.

This ratio is used by investors, finance professionals, and chartered accountants to understand the financial health of a company. The net profit margin ratio shows how effectively a business leverages its assets to gain profits and deliver value to shareholders.

In this article, we will understand the net profit margin ratio’s meaning, how to calculate it, the importance of net profit margin, and how to improve it.

## What is the net profit margin ratio?

The net profit margin or net income margin ratio is an indicator of the profit generated by a company after deducting all taxes. It denotes the profit a business can generate from its net sales or total revenue.

It gives the final profit of the business after subtracting all the overhead costs, like production, operational costs, administration expenses, sales-related costs, and income tax.

In simple terms, it represents the percentage of revenue that a company retains as profit. The net profit margin ratio is indicative of the financial well-being of a business and can also be used to compare the performances of competitors. If the net profit margin ratio is high, it signifies the efficiency of a company operationally and its ability to handle expenses.

## Example of net profit margin ratio

The net profit margin ratio is used by finance professionals to assess the profit generated by a business against a rupee of the revenue it generates.

For example, let us consider company A with a net margin of 18%. This is the profit left after deducting all the expenses required to carry out the business. This translates to a net profit of Rs. 0.18 generated against a revenue of Rs. 1.

## What does the net profit ratio indicate?

The net profit ratio indicates the ability of a business to keep its overheads or expenses under check and make spending efficient and optimal. The ratio indicates if the current operational practices of the company are in proper order.

The ratio also denotes the financial health of a company. It is also expressed as a percentage of the profit, making it easier to compare the profitability of different businesses, even if they are different in nature and size. Investors can assess if the management is taking the right steps to generate sales and keep a track record of good profits.

The net profit margin ratio does not include non-cash outflows like depreciation, accrued expenses, etc. Hence, it cannot be used to denote cash flows.

### The formula for the net profit ratio

To calculate the net profit ratio, you have to deduct all the costs and expenses from the revenue. Afterwards, convert the net margin into a percentage by multiplying it by 100.

Net profit margin ratio = Net profit of the business ⁄ Total revenue of the business x 100

Here,

• Net profit of the business: Also known as the bottom line, it is the post-tax earnings of the company after all operating, admin, and sales expenses have been deducted.
• Total revenue of the business: Also known as the top line of the business, it is the total revenue a company earns by selling goods and services over a given period.

## How to calculate the net profit ratio?

In the above-given formula, you have to subtract the sum of total expenses from the company's total revenue.

To calculate the net profit percentage, you have to divide the post-tax profit by the net sales of the business. It is the profit that is left after all income taxes, manufacturing expenses, and direct and indirect expenses have been accounted for.

Net profit is the take-home money for a company after deducting all its expenses.

### Example of calculation of net profit margin ratio

Let us assume a business ‘XYZ’ involved in food processing has a net sales of Rs. 5 crores. The net income of the company, after deducting all the expenses, including taxes, amounts to Rs. 90 lakhs according to the income statement.

Net Profit Margin of the company = Net profit of the business ⁄ Total revenue of the business * 100

=80,00,000/5,00,00,000 * 100

Net profit margin = 0.16 or 16%

The company XYZ has earned a net profit of 16% from its total sales. This means for every rupee that the company spent, Rs. 0.16 was the profit.

It is important to note that the profit margin of a company can vary; it could either be positive or negative. A negative profit margin means that the company was not able to make any profits during the given fiscal year.

## Importance of net profit margin ratio

The net profit margin ratio considers all the company's expenses and revenue, making it a critical metric that represents the financial health of a business.

Here are some of the factors that make net profit margin an important financial ratio:

### 1. Assessing the cost and pricing

When the net profit ratio is high, it indicates that the pricing strategy deployed by the company is efficient and can comfortably cover the expenses. When the profit margin is lower, it could indicate that the company should work on its pricing and reassess the costs to ensure higher profitability.

### 2. Comparison between companies

This ratio represents a percentage of a company's revenue, making it easier to compare companies with different market capitalisations. However, it is most useful for comparing companies within the same industry, as profit margins can vary significantly between industries.

### 3. Assessment for different periods

The net profit ratio can be used by a company to compare how much profit was generated for different accounting or fiscal years. This acts as a guiding light on whether the budgetary and financial measures employed by the company performed well or not. Additionally, tracking net margin ratios over time can help project a company's net income based on its revenue.

### 4. Lenders use it to evaluate risk

The net profit ratio proves to be useful when a company wants to apply for a loan. This ratio is assessed by lenders, such as banks or financial institutions, to understand whether the company is eligible for a loan. If a company has a higher net profit margin, it signals a strong cash flow, which increases the confidence of the lenders for repayment.

## What is a good net profit margin?

A good net profit ratio is not constant and changes from one industry to the other. Let us take the example of the retail sector, which is considered to be performing well when it has a net profit ratio that ranges from 0.5% to 0.35%, while in the case of the services industry, the ratio varies from 0.15% to 0.20%.

Generally speaking, a net profit ratio in the range of 10% to 20% is considered to be average. Hence, it is advised to compare the net profit ratio of a company to its previous performance to gauge its profit growth over the years.

A good net profit ratio indicates a competitive pricing strategy, where the business sells its products at higher prices, which can easily cover production and distribution expenses.

A low net profitability ratio can be due to high operational costs, poor management, low demand, or poor pricing.

## Limitations of net profit margin ratio

When calculating the net profit margin ratio, analysts often compare it to other companies to see which performs best.

However, this ratio can vary greatly between different industries. For instance, a technology company might have a high profit margin but lower revenue compared to a retail company, which could have a lower profit margin but higher revenue.

It's best to compare companies within the same industry and with similar business models.

There are other limitations to consider. It is easy to misinterpret the profit margin ratio and the cash flow figures. A low net profit margin doesn't always mean a company is performing poorly, and a high net profit margin doesn't always mean the company has high cash flows.

## How to improve the net profit margin ratio?

Here are a few things that companies can incorporate into their strategies to improve their net profit margins:

• Businesses should focus on promoting more sales, reducing operational expenses, or a combination of both to improve their net profit ratio. Companies can also introduce new products and services or enter new untapped markets.
• Businesses should, if possible, go for bulk purchase orders, improve their product designs, and automate processes by upgrading their technology to generate higher outputs.
• Companies should also look at implementing differential pricing based on customer segments, regions, or purchase volumes to reach more consumers in the market.

## Conclusion

The net profit margin ratio helps determine the profitability of a company. It provides a good perspective on the operational efficiency, management, and pricing structure of a business.

However, as an investor, it is important to not rely on just one metric and take a 360-degree view of your investments. It is also advised to take a holistic approach and look at other ratios of the company, its products, and the competitors before investing.

Ready to take control of your investments and maximise your returns? For a comprehensive investment strategy and expert guidance, explore the Bajaj Finserv Mutual Fund Platform, which can assist you with your investment needs.

The convenient and easy-to-use platform houses over 1,000 mutual funds schemes. It also allows for easy mutual fund comparison and selection, making it an excellent resource to help you build a well-balanced portfolio. The platform also has a lump sum calculator and an SIP calculator that help you plan your investments and estimate returns so that you can make a well-informed decision.

## Essential tools for all mutual fund investors

 Mutual Fund Calculator Lumpsum Calculator Step Up SIP Calculator Axis Bank SIP Calculator SBI SIP Calculator HDFC SIP Calculator Nippon India SIP Calculator ABSL SIP Calculator

What is a good net profit margin ratio?
The average net profit margin across various industries is 7.71%. However, your ideal profit margin may differ from this benchmark.

Generally, a 5% margin is considered low, 10% is healthy, and 20% is high. Yet, a one-size-fits-all approach isn't ideal for setting your business profitability goals.

What is the net profit margin ratio (%)?
Net profit is determined by subtracting all company expenses from its total revenue. The profit margin calculation yields a percentage. For example, a 10% profit margin means that for every Rs. 1 of revenue, the company earns Rs. 0.10 in net profit. Revenue signifies the total sales of the company during a specific period.

What does the net profit margin indicate?
The net profit margin ratio indicates the percentage of sales revenue a company retains after deducting all costs, including interest and taxes. This ratio is one of five key calculations used to assess profitability.

What is an example of a net profit margin?
Calculating the net profit margin is straightforward. Divide your net income by sales (or revenue, also known as the top line). For instance, if your sales amount to Rs. 10 lakh and your net income is Rs. 1 lakh, your net profit margin would be 10%.

How to improve the net profit margin ratio?
Companies can boost their net margin by enhancing revenues by selling more goods or services or raising prices. They can also increase their net margin by cutting costs, for example, by sourcing raw materials more affordably.

Is a high net profit margin ratio good?
A higher profit margin is typically preferred because it indicates that the company generates more profit from its sales.

However, profit margins can differ significantly between industries.

What is the difference between net margin and net profit margin?
The gross profit margin is calculated by dividing gross profit by total revenue and multiplying by 100, yielding a percentage that represents the income retained as profit after accounting for the cost of goods sold. On the other hand, the net profit margin, or net margin, is the percentage of net income generated from a company's revenue.

What affects the net profit margin ratio?
Quantitative factors are the clear and easily identifiable numerical aspects that impact your profit margin. These include your net profits, sales earnings, and merchandise costs. To get a basic understanding of these key variables, examine your income statement, focusing on net revenues and cost of goods sold.

## Bajaj Finserv App for All Your Financial Needs and Goals

Trusted by 50 million+ customers in India, Bajaj Finserv App is a one-stop solution for all your financial needs and goals.

You can use the Bajaj Finserv App to:

• Apply for loans online, such as Instant Personal Loan, Home Loan, Business Loan, Gold Loan, and more.
• Explore and apply for co-branded credit cards online.
• Invest in fixed deposits and mutual funds on the app.
• Choose from multiple insurance for your health, motor and even pocket insurance, from various insurance providers.
• Pay and manage your bills and recharges using the BBPS platform. Use Bajaj Pay and Bajaj Wallet for quick and simple money transfers and transactions.
• Apply for Insta EMI Card and get a pre-approved limit on the app. Explore over 1 million products on the app that can be purchased from a partner store on Easy EMIs.
• Shop from over 100+ brand partners that offer a diverse range of products and services.
• Use specialised tools like EMI calculators, SIP Calculators
• Check your credit score, download loan statements and even get quick customer support—all on the app.
Download the Bajaj Finserv App today and experience the convenience of managing your finances on one app.

## Do more with the Bajaj Finserv App!

UPI, Wallet, Loans, Investments, Cards, Shopping and more

## Disclaimer:

Bajaj Finance Limited (“BFL”) is an NBFC offering loans, deposits and third-party wealth management products.

The information contained in this article is for general informational purposes only and does not constitute any financial advice. The content herein has been prepared by BFL on the basis of publicly available information, internal sources and other third-party sources believed to be reliable. However, BFL cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed.

This information should not be relied upon as the sole basis for any investment decisions.Hence, User is advised to independently exercise diligence by verifying complete information, including by consulting independent financial experts, if any, and the investor shall be the sole owner of the decision taken, if any, about suitability of the same.

Show All Text

## Disclaimer:

Bajaj Finance Limited ("BFL") is registered with the Association of Mutual Funds in India ("AMFI") as a distributor of third party Mutual Funds (shortly referred as 'Mutual Funds) with ARN No. 90319

BFL does NOT:

(i) provide investment advisory services in any manner or form:

(ii) carry customized/personalized suitability assessment:

(iii) carry independent research or analysis, including on any Mutual Fund schemes or other investments; and provide any guarantee of return on investment.

In addition to displaying the Mutual fund products of Asset Management Companies, some general information is sourced from third parties, is also displayed on As-is basis, which should NOT be construed as any solicitation or attempt to effect transactions in securities or the rendering any investment advice. Mutual Funds are subject to market risks, including loss of principal amount and Investor should read all Scheme/Offer related documents carefully. The NAV of units issued under the Schemes of mutual funds can go up or down depending on the factors and forces affecting capital markets and may also be affected by changes in the general level of interest rates. The NAV of the units issued under the scheme may be affected, inter-alia by changes in the interest rates, trading volumes, settlement periods, transfer procedures and performance of individual securities forming part of the Mutual Fund. The NAV will inter-alia be exposed to Price/Interest Rate Risk and Credit Risk. Past performance of any scheme of the Mutual fund do not indicate the future performance of the Schemes of the Mutual Fund. BFL shall not be responsible or liable for any loss or shortfall incurred by the investors. There may be other/better alternatives to the investment avenues displayed by BFL. Hence, the final investment decision shall at all times exclusively remain with the investor alone and BFL shall not be liable or responsible for any consequences thereof.

Investment by a person residing outside the territorial jurisdiction of India is not acceptable nor permitted.

Disclaimer on Risk-O-Meter:

Investors are advised before investing to evaluate a scheme not only on the basis of the Product labeling (including the Riskometer) but also on other quantitative and qualitative factors such as performance, portfolio, fund managers, asset manager, etc, and shall also consult their Professional advisors, if they are unsure about the suitability of the scheme before investing.

Show All Text