Net profit margin is a very important figure for business documentation and planning. You should be paying attention to how your net profit margin compares to your competitors’ margins.
What Is Profit Margin?
Profit margin is a measurement of a business’s profitability, articulated as a percentage.
Another way to think about profit margin: it’s the ratio of profit turned by a business compared to the total amount of revenue that flowed into the business over a specified time period.
Profit margin is used by lenders, business owners, and investors as a method for determining how much profit a company earns from every sale of a good or service.
There are several categories of profit margin that incorporate expenses in distinct ways and, therefore, are calculated differently. Common forms of profit margin include gross profit margin, operating profit margin, pre-tax profit margin, and net profit margin.
What Is Net Profit Margin?
Net profit margin is often called the “bottom line” of your business. In a sense, it’s the most holistic calculation of profit margin because it factors in all your business’s expenses, including taxes.
Lenders, investors, and other stakeholders will ask about net profit margin because it provides an easy-to-understand metric of profitability.
How Do You Calculate Net Profit Margin?
To calculate your company’s net profit margin, you must first know your operating profit income.
Operating income is a company’s total revenue minus operating expenses, such as labor, rent, and cost of goods sold (COGS). Don’t subtract taxes or interest expenses just yet.
To calculate net profit margin, take your operating income and then subtract tax expenses and interest expenses.
Divide this number by your total revenue. The result will be a decimal expression of your net profit margin percentage.
What Is a Good Net Profit Margin?
Unfortunately, there’s no simple answer to what your goal net profit margin should be. Healthy net profit margin targets vary widely based on industry and location—restaurants, for example, are known for operating on very slim profit margins, commonly between 3% and 5%. And while many factors impact profit margin, a business in a state with a high tax burden might expect a less robust profit margin than one in a low-tax state.
Databases exist online that list the net-profit margin ranges that companies in different industries should reach. Do some research and contact local business authorities for guidance on what sort of net profit margin your company should expect.
In a one-dimensional sense, the Corporate Finance Institute says that a 10% net profit margin is considered average for many American small businesses, while 20% is considered high—however, this range changes considerably depending on your field.
What Factors Determine Net Profit Margin?
Two factors impact net profit margin: income and expenses. From a purely mathematical perspective, you can increase your net profit margin by either increasing revenue or decreasing expenses—or perhaps both. It’s easier said than done, but thinking this way gives you a straightforward approach to bettering your margins.