Which of the following would most likely increase the net profit margin ratio?

What Is Net Profit Margin?

The net profit margin, or simply net margin, measures how much net income or profit is generated as a percentage of revenue. It is the ratio of net profits to revenues for a company or business segment.

Net profit margin is typically expressed as a percentage but can also be represented in decimal form. The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit.

Key Takeaways

• Net profit margin measures how much net income is generated as a percentage of revenues received.
• Net profit margin helps investors assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are under control.
• Net profit margin is one of the most important indicators of a company's overall financial health.

Understanding Net Profit Margin

Net profit margin is one of the most important indicators of a company's financial health. By tracking increases and decreases in its net profit margin, a company can assess whether current practices are working and forecast profits based on revenues.

Because companies express net profit margin as a percentage rather than a dollar amount, it is possible to compare the profitability of two or more businesses regardless of size.

This metric includes all factors in a company's operations, including:

• Total revenue
• Additional income streams
• COGS and other operational expenses
• Interest expense on debt obligations
• Investment income and income from secondary operations 
• One-time payments for unusual events such as lawsuits and taxes

Investors can assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained.

For example, a company can have growing revenue, but if its operating costs are increasing at a faster rate than revenue, its net profit margin will shrink. Ideally, investors want to see a track record of expanding margins, meaning that the net profit margin is rising over time.

Most publicly traded companies report their net profit margins both quarterly during earnings releases and in their annual reports. Companies that can expand their net margins over time are generally rewarded with share price growth, as share price growth is typically highly correlated with earnings growth.

Formula and Calculation for Net Profit Margin

Net profit margin=R−COGS−E−I−TR∗100=Net incomeR∗100where:R=RevenueCOGS=The cost of goods soldE=Operating and other expensesI=InterestT=Taxes\begin{aligned} \text{Net profit margin} &= \frac{R - COGS - E - I - T}{R}*100\\ &= \frac{\text{Net income}}{R}*100\\ \textbf{where:}\\ R &= \text{Revenue}\\ COGS &= \text{The cost of goods sold}\\ E &= \text{Operating and other expenses}\\ I &= \text{Interest}\\ T &= \text{Taxes} \end{aligned}Net profit marginwhere:RCOGSEIT​=RR−COGS−E−I−T​∗100=RNet income​∗100=Revenue=The cost of goods sold=Operating and other expenses=Interest=Taxes​

1. On the income statement, subtract the cost of goods sold (COGS), operating expenses, other expenses, interest (on debt), and taxes payable.
2. Divide the result by revenue.
3. Convert the figure to a percentage by multiplying it by 100.
4. Alternatively, locate net income from the bottom line of the income statement and divide the figure by revenue. Convert the figure to a percentage by multiplying it by 100.

Net Profit Margin vs. Gross Profit Margin

Gross profit margin is the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). COGS measures the cost of raw materials and expenses associated directly with the creation of the company's primary product, not including overhead costs such as rent, utilities, freight, or payroll.

Gross profit margin is the gross profit divided by total revenue and is the percentage of income retained as profit after accounting for the cost of goods. Gross margin is helpful in determining how much profit is generated from the production of a company's goods because it excludes other items such as overhead from the corporate office, taxes, and interest on a debt.

Net profit margin, on the other hand, is a measure of net profit to revenue.

Net income is also called the bottom line for a company as it appears at the end of the income statement.

Limitations of Net Profit Margin

Net profit margin can be influenced by one-off items such as the sale of an asset, which would temporarily boost profits. Net profit margin doesn't hone in on sales or revenue growth, nor does it provide insight as to whether management is managing its production costs.

It's best to utilize several ratios and financial metrics when analyzing a company. Net profit margin is typically used in financial analysis along with gross profit margin and operating profit margin.

Hypothetical Example of Net Profit Margin

Imagine a company that reports the following numbers on its income statement:

• Revenue: $100,000
• Operating costs: $20,000
• COGS or cost of goods sold: $10,000
• Tax liability: $14,000
• Net profits: $56,000

Net profit margin is thus 0.56 or 56% ($56,000/$100,000) x 100. A 56% profit margin indicates the company earns 56 cents in profit for every dollar it collects.

Let's take a look at another hypothetical example, using the made-up Jazz Music Shop's FY 2025 income statement.

Here, we can gather all of the information we need to plug into the net profit margin equation. We take the total revenue of $6,400 and deduct variable costs of $1,700 as well as fixed costs of $350 to arrive at a net income of $4,350 for the period. If Jazz Music Shop also had to pay interest and taxes, that too would have been deducted from revenues.

The net profit margin is calculated by taking the ratio of net income to revenue. The net profit margin is calculated as follows:

• $4,350 / $6,400 = .68 x 100 = 68%

Real-World Example of Net Profit Margin

Below is a portion of the income statement for Apple Inc. as reported for the quarter ending on Dec. 29, 2018:

• Net sales or revenue was $84.310 billion (highlighted in blue).
• Net income was $19.965 billion for the period (highlighted in green). 
• Apple's net profit margin is calculated by dividing its net income of $19.965 billion by its total net sales of $84.310 billion. Total net sales are used as the top line for companies that have experienced customer returns of their merchandise, which are deducted from total revenue.
• Apple's net profit margin was 23.7% or ($19.965 billion ÷ $84.310 billion x 100).

A net profit margin of 23.7% means that for every dollar generated by Apple in sales, the company kept just shy of $0.24 as profit.

Source: Apple, Inc.

Why Is the Net Profit Margin Important?

The net profit margin is perhaps the most important measure of a company's overall profitability. It is the ratio of net profits to revenues for a company or business segment. Expressed as a percentage, the net profit margin shows how much profit is generated from every $1 in sales, after accounting for all business expenses involved in earning those revenues. Larger profit margins mean that more of every dollar in sales is kept as profit.

How Can a Company Improve Its Net Profit Margin?

While the average net margin for different industries varies widely, businesses can gain a competitive advantage in general by increasing sales or reducing expenses (or both). Boosting sales, however, often involves spending more money to do so, which equals greater costs.

Cutting too many costs can also lead to undesirable outcomes, including losing skilled workers, shifting to inferior materials, or other losses in quality. To reduce the cost of production without sacrificing quality, the best option for many businesses is expansion. Economies of scale refer to the idea that larger companies tend to be more profitable.

How Is Net Margin Different From Other Profit Margin Measures?

Net profit margin takes into account all costs involved in a sale, making it the most comprehensive and conservative measure of profitability. Gross margin, on the other hand, simply looks at the costs of goods sold (COGS) and ignores things such as overhead, fixed costs, interest expenses, and taxes. Operating margin further takes into account all operating costs but still excludes any non-operating costs.

What Are Some High- and Low-Profit Margin Industries?

High-profit margin sectors typically include those in the services industry, as there are fewer assets involved in production than an assembly line. Similarly, software or gaming companies may invest initially while developing a particular software/game and cash in big later by simply selling millions of copies with very few expenses.

Operations-intensive businesses such as transportation, which may have to deal with fluctuating fuel prices, drivers’ perks and retention, and vehicle maintenance, usually have lower profit margins. Automobiles also have low-profit margins, as profits and sales are limited by intense competition, uncertain consumer demand, and high operational expenses involved in developing dealership networks and logistics.

The Bottom Line

The net profit margin measures the profits of a business as a percentage of total revenue. Along with other metrics, the net margin is used to make data-based decisions about how effectively a company uses its revenue. Each industry has different profit margins, so it is important to consider all possible factors when evaluating the net margins of different companies.

Which of the following can increase net profit margin?

Which would increase the profit margin?

What does it mean when profit margin ratio increases?

What affects net profit margin?