What is net profit margin? Net profit margin or net margin is a business's net profit divided by
its revenue it's a profitability ratio that measures how much net profit a business is
able to generate for each dollar of revenue earned usually net profit margin is shown as a percentage
so we can multiply this by 100. before we jump into the example let's take a moment to refresh
ourselves on a couple of things first profit we can find profit in a business's income statement
the financial report that summarizes its revenues and expenses over a period of time profit is the
financial gain generated in a business when its revenues are bigger than its expenses but what is
net profit? The problem with this income statement is that businesses often have several different
types of expenses to get a better understanding of these costs we can expand it at the top we
subtract the direct cost of sales which gets us to gross profit then we remove all of the
operating expenses like research and development selling general and administrative expenses
depreciation and amortization which leaves us with operating profit then at the bottom we take away
interest and tax to reach net profit also known as the bottom line all right then so what is
net profit margin? Net profit margin is net profit divided by revenue it tells us how much net profit
a business is able to generate for each dollar of revenue earned it takes into consideration
all of the businesses expenses that we can see above the bottom line in the income statement
that's the fundamental difference between net profit margin versus the other margin ratios
so let's have a crack at calculating net profit margin this is the income statement for a tech
company called MAD it summarizes their revenue earned and expenses incurred over the past year
how do we work out MAD's net profit margin? We'll start with revenue MAD earned one billion dollars
during the course of the year and on the bottom line we can see that they generated
120 million dollars in net profit after deducting all of their expenses so MAD's net profit margin
is 120 million dollars in net profit divided by 1 billion dollars in revenue that means they
generated 12 cents of net profit on each dollar of revenue they earned which is 12% if we multiply by
a hundred but before you click away let's make some comparisons first we'll look into MAD's
year on year movement in net profit margin these are MAD's income statements for the last two years
on the left we have the current year where they generated 120 million dollars in net
profit on one billion dollars of revenue a 12% net profit margin which we worked out already
and on the right we have the previous year in which MAD generated 49 million dollars in
net profit from 700 million dollars in revenue 49 million divided by 700 million is a seven percent
net profit margin so year on year MAD managed to improve their top line revenue by 300 million
dollars and they were able to increase their net profit margin by five percent this resulted in
a huge 71 million dollar increase in their net profit on the bottom line but how do they fare
against similar businesses? Here are the current year income statements for MAD and INLET a direct
competitor in the same industry straight away we can see that INLET earned much more revenue
7.8 billion dollars they also managed 1 billion 872 million dollars in net profit but how does
their net profit margin compare against MAD's 1.872 billion dollars divided by 7.8 billion dollars
is 0.24 or 24 percent which is significantly more than MAD's 12 percent
so INLET is earning more revenue and they're converting a higher proportion of that revenue
into net profit what can cause a decrease in net profit margin well we know the net profit margin
is net profit divided by revenue in the income statement we saw that net profit is equivalent to a
business's operating profit less its interest and tax expenses if we split out these fractions and
divide operating profit by revenue then we can see that net profit margin is the same as operating
profit margin minus interest expenses divided by revenue minus tax expenses divided by revenue
so there are a few factors that could cause a decreased net profit margin first the
businesses operating margin could have decreased alternatively the interest or tax expenses could
have risen as a proportion of revenue what causes an increase in net profit margin?
well the equation is the same as before but we can spin the arrows around operating profit margin
could have increased which would flow through and have a direct impact on net profit margin
alternatively the businesses interest or tax expenses might have dropped as a proportion of
revenue earned thanks to all my channel members for your generous contributions what financial
ratios would you like to see next? Let me know in the comments and i'll catch you in the next one