What is Net Profit Margin?
Net profit margin, or simply “net margin,” is the calculated amount of each sales dollar a company retains after deducting costs.
This calculation takes all revenues and costs into account to completely describe a company’s profit.
The Net Profit Margin Formula
The net profit margin formula may appear daunting but is in fact very straightforward to use.
Once we have plugged some numbers into this formula, the picture becomes much clearer.
Also note that multiplying the entire result by one hundred will give us a decimal value that can (and often is) expressed as a percentage of total revenue.
For our example, let’s use the values from the table below.
With this information plugged into the formula, we can calculate the net profit margin for our example ABC Corp, as shown below.
Cleaning that up a little bit gives us the following result:
As we can see, the net profit margin for ABC Corp is 33.1%. This means that of every sales dollar—or dollar of revenue—ABC Corp keeps 33.1 cents after all costs have been accounted for.
Gross Margin and Net Profit Margin
Gross margin is similar to net margin in that it calculates how much money a company retains from revenue after costs have been deducted.
However, gross margin takes only direct costs into account and does not reflect the toll that indirect costs can have on the bottom line.
Direct costs are those that are directly associated with the production of products or services. Indirect costs include everything else; overhead costs such as office expenses, rent, utilities, and administrative costs are classified as indirect costs.
As we have seen with the net profit margin formula, this calculation includes the total cost profile for a company.
This does not mean that the gross margin calculation is useless, however. Gross margin calculations are essential to the forecasting and budgeting processes. A firm understanding of how much money goes into producing revenue is helpful in determining the amount of money that will be available to cover other indirect costs.
Additionally, it is always a best practice for managers, small business owners, and decision-makers to track costs. Runaway costs can decimate budgets and chip away at profitability.
A Note about COGS
COGS, or cost of goods sold, is a basic cost metric that is included in both the gross margin calculation and the net profit margin calculation. COGS calculations include only direct costs and are based on the flow of inventory.
To calculate the cost of goods sold, add the starting inventory for a period to any purchases for the period, then subtract the period’s ending inventory.
Once a cost of goods sold value is reached, you will be ready to calculate gross and net profit margins.