Net Profit Margin Definition | Meaning | Importance | Examples

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Net Profit Margin Definition with Example

Net profit Margin Definition – “It refers to the ratio of Net profit to Sales Revenue.”

Profit margin is the ratio which measures the percentage of the net income from the net sales of an organization. It s also known as profit margin. In simple words, it is basically the revenue left after deducting all the expenses.

It acts as a financial tool to compare one organisation with another within the same industry. Some organizations have a huge profit margin, then some have very less margin. A low profit margin doesn’t mean that company is not doing well. For example, Wal -mart operates on a very large scale and is able to get quite low profit margin. But it has provided higher returns to its shareholders.

The net profit margin depends upon the extent of competition, elasticity of demand, product differentiation, etc.

Net profit Margin Formula

Profit Margin = Net Income/ Net Sales

Here, Net Sales = Gross Sales – Sales returns – sales tax – discounts

Net Profit Margin Example

To understand net profit margin definition clearly, let’s have a look over an example.

Income Statement of ABC Ltd.

for the year ending 31st March 2017

Total Revenue ………………………………………………………………………………………………………1,00,000
Cost of goods sold ……………………………………………………………………………………………….. 30,000

Gross profit …………………………………………………………………………………………………………..70,000

Operating Expenses
Salaries …………………………………………………………………………………………………………………….5,000
Rent ………………………………………………………………………………………………………………………….3,000
Depreciation ………………………………………………………………………………………………………………1,000
Total Operating expenses …………………………………………………………………………………………….9,000

Interest Expenses ………………………………………………………………………………………………………..5,000
Taxes …………………………………………………………………………………………………………………………3,000

Net Profit/ Net Income …………………………………………………………………………………………………53,000

Net profit Margin = Net Profit / Net sales

= 53,000/1,00,000 × 100

= 0.53 × 100

= 53%

Related Financial Terms of Net Profit Margin

Importance of Net Profit Margin

Net profit margin is very important from the point of view shareholders. Shareholders look at profit margin to see how good a company is in converting the revenues into profit. The most important thing to note is that, profit margin is not the measure of how much a company earns. This is because the income statement also consist of the non cash items such as depreciation and amortization.

The decline in net profit margin is a real problem for the organization. It indicates that something is not well within the company. It could be because of decreasing sales, customer dissatisfaction or inappropriate management, etc. So, it is very important to make optimum utilization of all the resources.

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