A Complete Guide To Net Profit Ratio (2024)

Net Profit Ratio, also called Net Profit Margin or Net Profitability Ratio, is one of the most important metrics to measure a business's profitability and financial success. It is the ratio of net profits to the total sales (or revenue) of the company for a given period and is expressed as a percentage.

In essence, the Net Profit Ratio expresses how much profit is generated for every $1 that is made in sales. If the Net Profit Ratio is 30%, it means 30% of every dollar, or 30 cents is profit. It also gives a measure of the company's expenditure for every dollar earned, which in this case is 70% or 70 cents. Clearly, the larger the Net Profit Ratio, the better.

The Net Profit Ratio gives a measure of a company's capability to keep expenses under control. It evaluates how efficiently (or inefficiently) a company is spending money.

The Net Profit Ratio represents final company performance. It positions the company as a profitable one, or not. Consequently, the Net Profit Ratio can help a business improve efficiency for the coming year.

By understanding how much the company is spending to make a dollar, they put a tangible value to expenditure that they can start to control and reduce by reducing outgoing amounts like the cost of goods sold, for example.

In this article, we cover in-depth everything you need to know about Net Profit Ratio, how to differentiate it from other profitability ratios, how to calculate it, and how to draw insights from it. We talk about:

  • Types of Profitability Ratio
  • Return on Equity
  • Earnings Per Share
  • Dividend Per Share
  • Price Earnings Ratio
  • Return on Capital Employed
  • Return on Assets
  • Gross Profit Ratio
  • Net Profit Ratio
  • Difference Between Net Profit and Gross Profit
  • Net Profitability From Net Profits
  • Measuring Net Profitability
  • What Is Considered A Good Net Profit Ratio & How To Improve It
  • Limitations of Net Profit Ratio

Types of Profitability Ratio

Before we move into understanding the Net Profit Ratio, it is important to get a basic understanding of the types of profitability ratios that are calculated for every company.

Return on Equity

The return on equity ratio represents the profitability of the equity fund that is invested in the company. It measures the profits generated from the investments made by shareholders. It is calculated by dividing the company profits after tax by the net worth, where the net worth is the sum of investments (equity share capital, reserve, and surplus).

Formula:

Equity = Profit after Tax ÷ Net worth (sum of investments)

The earning per share ratio is a measure of profitability per outstanding share of common stock of the company. It represents the company's profitability from the point of view of an ordinary shareholder. It is calculated by dividing net profit by the total no of shares outstanding.

Formula:

Earning Per Share = Net Profit ÷ Total no of shares outstanding

The dividend per share ratio measures the amount of dividend disbursed by the company to its shareholders per outstanding share. A high ratio is indicative of surplus profits and also indicates a profitable business. it is measured by dividing the total amount disbursed to shareholders by the total number of shares outstanding.

Formula:

Dividend Per Share = Amount Distributed to Shareholders ÷ No of Shares outstanding

Price Earnings Ratio

A company's price to earnings ratio is a measure of its share price to its earnings per share. It indicates to investors if the company's shares are undervalued or overvalued. It also gives investors a sense of the company's earnings, profitability, and payback period to investors.

Formula:

Price Earnings Ratio = Market Price of Share ÷ Earnings per share

Return on Capital Employed

The return on capital employed gives a measure of the company's return percentage for the capital invested. It gives the profitability of the company after taking into account the total capital used. It is the ratio of net profits to capital investment, where the capital investment is generally the investment made for the business to function.

Formula:

Return on Capital Employed = Net Operating Profit ÷ Capital Employed

Return on Assets

Return on assets is a measure of profits per dollar of assets owned. It indicates the company's profitability relative to the total assets owned. It gives a measure of how efficiently the company is using its assets to generate revenue.

Formula:

Return on Assets = Net Profit ÷ Total Assets

Gross Profit Ratio

Gross profit is the total revenue earned by the company less the cost of goods sold, or the cost of providing service. The gross profit ratio is the ratio of gross profits to total sales made.

Formula:

Gross Profit Ratio = Gross Profit ÷ Sales

Net Profit Ratio

Net profits are the profits made by the company after deducting all expenses - cost of goods sold, cost of service, salaries, utilities, taxes, etc. It is calculated by deducting all operating expenses from the gross profit. The ratio of net profit to the total sales done is the net profit ratio.

Formula:

Net Profit Ratio = Net Profit ÷ Sales

Difference Between Net Profit and Gross Profit

A common confusion arises when discussing net profit and gross profit. They are both measures of a company's profits, but they have different calculations and thus different implications.

Assume the following table to be a company's annual income statement:

Total revenue$350,000
Cost of goods sold$75,000
Operating expenses
Payroll$25,000
Utilities$10,000
Rent$15,000
Depreciation$10,000
Total operating expenses$60,000

A company's gross profits are its profits after deducting the COGS from its revenue. In this example, the company's gross profits are $350,000 - $75,000 = $275,000

A company's net profits are the profits after deducting ALL expenditure from its revenue. In this example, the company's net profits are $350,000 - $75,000 - $60,000 = $215,000. You can also calculate it as the company's gross profits less the total operating expenditure.

Why are there two separate measures of profits, and what are their implications? Understanding that will give you a complete understanding of the difference between the two.

Gross Profit is a measure of how efficiently the company is using its labor force and supplies in order to manufacture goods. The higher the gross profits, the lesser the cost of goods sold, or in other words, the lesser the cost of making goods, which indicates the goods are being manufactured efficiently. Gross profit directly relates products to profits by measuring how much profit is generated by the manufactured goods that were sold.

The gross profits are also a measure of how much funds are available for business operations. the gross profits are used (ideally) to pay operating expenses.

Net profit is a measure of profits earned after deducting all expenses from the total revenue (or after deducting operating expenses from the gross profit). This number indicates the actual surplus money available as profits to the owners of the company.

The net profit is a measure of the company's financial health. A high net profit indicates a business that is earning high revenue and managing it with low expenses. It also shows how much money is available as surplus, and this amount can be used to grow the business and indicates a thriving business.

Net Profitability From Net Profits

Net profitability and net profits are different terminologies. Net profits, discussed in the earlier section, shows how much money is available to the owners as surplus. In the example above, the company had $215,000 available to the owners.

Profitability, on the other hand, is not an absolute monetary value but a relative number, a percentage that measures performance. Net Profitability, therefore, is a measure of how good or bad the net profits have been that year.

Measuring Net Profitability

The formula for net profitability is

Net Profitability = (net profit ÷ net revenue) x 100.

In the example above, net profitability would be (215,000 ÷ 350,000) x 100 = 61.43%

This company is able to create 61% profits from every dollar it earns and expends only 39% of every dollar it earns.

You can now see how profitability is a measure of performance. it does not indicate how much money is available, it indicates how well the company worked towards managing its expenses so it could turn over more profits for every dollar.

What Is Considered A Good Net Profit Ratio & How To Improve It

There's no absolute answer to what is considered a good or bad net profit ratio, it depends on the industry and your company's past performance.

In the retail sector, for example, anything between 0.5% to 3.5% is considered a good net profit ratio. This might not, however, be considered good for other businesses. In general, though, aiming for a net profit ratio of 10% - 20% is considered average. A better measure for your business would be to compare the previous year's net profit ratio and try to improve on it.

If you believe your business has a low net profit ratio or you are not seeing any increase over the years, there are some measured steps you can take to improve it.

1. Increase Revenue - The first and most obvious way to increase the net profit ratio is by increasing revenue. You can do this is in one of three ways - sell the same amount of products but increase the prices of the products, keep the prices of products the same but increase marketing efforts and sell more quantities, or both, increase the pricing and the quantity through marketing.

2. Reduce Cost Of Goods Sold (COGS) - If you're not able to increase revenue, the next area to look at is to increase gross profits by reducing the cost of goods sold. You can achieve this by finding cheaper vendors or cheaper alternatives to the raw materials being used, and by reducing other costs that are included in calculating COGS.

3. Reduce Operating Expenses - The next area you can focus on to increase the Net Profit Ratio is the company operating expenses. There are some expenses like salaries that are rigid and cannot be reduced, but there will also be some expenses that can be reduced or even be totally avoidable. If you're spending on client meals, expensive conference rooms, etc, you can save up by looking for cheaper alternatives.

Limitations of Net Profit Ratio

Measuring net profit profitability ratio and using solely this metric to measure performance is not good practice. Here are a few limitations of doing so:

1. Cannot be used to compare companies

Like we mentioned earlier, the measure of good or bad Net Profit Ratio depends on the industry. If investors were to compare companies solely based on Net Profit Ratios, they would always favor high ticket sales sectors like real estate or jewelry stores than say a local retail store. Net Profit Ratio cannot be used as a measure of comparing companies.

2. Can be inflated

Net profit ratio can be manipulated by one-time earnings like through a sale of an asset. This would show up on the balance sheet as an earning and boost profits for that period resulting in a high Net Profit Ratio. While it is a good measure of company performance, it should not be the only measure because of reasons like this. Analysts should take into account other ratios as well when evaluating a company's financial status.

3. Is low for companies with debt

A company that has debt financing will have higher interests on their balance sheet and this will increase operating costs, thereby lowering the net profit ratio. This can become an unfair disadvantage if the company were to apply for funding and investors only analyzed net profit ratio.

4. Depreciation expenses affect the net profit ratio

Similar to companies with debt, companies with high property plant & equipment (PP&E) assets will record higher depreciation on their balance sheet which will increase operating costs and lower net profit ratio. This, again, is an unfair method of evaluating the company.

Conclusion

Net profit ratio is an important metric that every financial analyst and company founder should know, should calculate, and should track. It is a good way of quickly judging a company's financial health.

That being said, it should not be the only metric that is considered when analyzing a company's financial status. Net profit ratio should rather be used by businesses to improve internal operations.

The aim should be to increase net profits by increasing revenue by selling more products or services or by reducing operating costs. This was of leveraging net profit ratio to compare company performance helps it grow financially.

Key Takeaways

  • The net profit ratio is a subset of profitability ratios and is the ratio of net profits to the total sales (or revenue) of the company for a given period
  • The net profit ratio is a measure of a company's capability to keep expenses under control. It also indicates how much profits were made
  • It is different from the gross profit ratio which is the ratio of gross profits to total sales. Gross profits are calculated by deducting only COGS from the revenue whereas net profits are calculated by deducting all expenses from the revenue
  • The net profit ratio is an indicator of profitability but should be the only metric used to measure profitability because it can be skewed or inflated

Related Articles

Financial Ratios - All you Need to KnowAfter striving for months to generate revenue as a company, how do you ascertainyour financial performance? Or when you want to invest in a company, how do youknow whether it is a profitable buy or not? Most importantly, how do you analyzewhere your firm stands financially in the competitive mark…Deskera BlogRhema Hans
What is a Debt Ratio? Guide with ExamplesOne of the most crucial parameters to assess the health of a particular companyis its financial position. The debt ratio, also known as the risk gearing ratio,is used to carry out the financial leverage of a company and to calculate theweight of the debt ratio and total debt and financial liabili…Deskera BlogDeskera Content Team
What are Accounting Ratios?Accounting: the one word a majority of the people seem to be scared of. Numbercrunching isn’t everyone’s cup of tea, right? However, once you understand thepurpose of it, accounting starts to make more sense than anything else. It makes total sense too. Every business setup needs to operate with…Deskera BlogDeskera Content Team
What is a Quick Ratio? Guide with ExamplesQuick ratios are the liquidity ratios used to provide the number of current assets [https://www.deskera.com/blog/assets/] paid out of the current liabilities [https://www.deskera.com/blog/liabilities/…Deskera BlogDeskera Content Team

#CRM

A Complete Guide To Net Profit Ratio (2024)

FAQs

A Complete Guide To Net Profit Ratio? ›

Net profits are the profits made by the company after deducting all expenses - cost of goods sold, cost of service, salaries, utilities, taxes, etc. It is calculated by deducting all operating expenses from the gross profit. The ratio of net profit to the total sales done is the net profit ratio.

How do you calculate net profit ratio? ›

It measures a company's profitability after taxes, expressing net profit as a percentage of revenue. A good net profit ratio varies by industry, with 10-20% considered average. The formula for calculating the net profit ratio is (Net Profit / Net Sales) x 100.

What is considered a good net profit ratio? ›

As a rule of thumb, 5% is a low margin, 10% is a healthy margin, and 20% is a high margin.

What are the 5 profitability ratios? ›

Profitability Ratios:
  • Return on Equity = Profit After tax / Net worth, = 3044/19802. ...
  • Earnings Per share = Net Profit / Total no of shares outstanding = 3044/2346. ...
  • Return on Capital Employed = ...
  • Return on Assets = Net Profit / Total Assets = 3044/30011. ...
  • Gross Profit = Gross Profit / sales * 100.
Jun 15, 2024

How do you calculate net profit ratio calculator? ›

Net profit / Revenue x 100 = Net profit margin. To run this formula, you first need to calculate your net profit, which is sales revenue minus expenses minus taxes. Or sales revenue minus expenses, if you want pre-tax net profit margin. Net profit margin shows what portion of your revenue turns into profits.

What is the formula for net profit? ›

Net profit is gross profit minus operating expenses and taxes.

What is the formula for net profit ratio in Excel? ›

Calculation of net profit margins by using a formula: Net Profit Margin = (Net Profit ⁄ Total revenue) x 100. Net Profit Margin = (INR 30/INR 500) x 100. Net Profit Margin= 6.00%

What is the average net profit for a small business? ›

As reported by the Corporate Finance Institute, the average net profit for small businesses is about 10 percent. Here are some examples reported by New York University—note the wide range of actual profit margins reported in the study: Banks: 31.31% to 32.61% Financial Services: 8.87% to 32.33%

What is the ideal net profit percentage? ›

What is a Good Profit Margin? You may be asking yourself, “what is a good profit margin?” A good margin will vary considerably by industry, but as a general rule of thumb, a 10% net profit margin is considered average, a 20% margin is considered high (or “good”), and a 5% margin is low.

How to improve net profit ratio? ›

Focus on increasing efficiency and reducing costs. This can include implementing better inventory management systems, streamlining operations, and negotiating better deals with suppliers. At the same time, you should also focus on growing your revenue by expanding your customer base and increasing sales.

What are profitability ratios for dummies? ›

Profitability ratios assess a company's ability to earn profits from its sales or operations, balance sheet assets, or shareholders' equity. They indicate how efficiently a company generates profit and value for shareholders. Profitability ratios include margin ratios and return ratios.

What is the P&L ratio formula? ›

The profit/loss ratio is the average profit on winning trades divided by the average loss on losing trades over a specified time period.

What is the best measure of profit? ›

A good metric for evaluating profitability is net margin, the ratio of net profits to total revenues.

How do you find the net profit ratio? ›

Net Profit Margin = Net Profit ⁄ Total Revenue x 100

The result of the profit margin calculation is a percentage – for example, a 10% profit margin means for each $1 of revenue the company earns $0.10 in net profit.

What is a good profit margin for a small business? ›

What's a good profit margin for a small business? Although profit margin varies by industry, 7 to 10% is a healthy profit margin for most small businesses. Some companies, like retail and food, can be financially stable with lower profit margin because they have naturally high overhead.

How much profit should you make on a product? ›

But in general, a healthy profit margin for a small business tends to range anywhere between 7% to 10%. Keep in mind, though, that certain businesses may see lower margins, such as retail or food-related companies. That's because they tend to have higher overhead costs.

How do you calculate the profit ratio? ›

It represents the percentage of each dollar of sales that is kept as profit after deducting all expenses, including operating expenses, taxes, interest, and depreciation. The profit ratio is calculated by dividing the net profit by the total revenue of the company and expressing the result as a percentage.

How to calculate net income ratio? ›

The formula for calculating net income is:
  1. Revenue – Cost of Goods Sold – Expenses = Net Income. The first part of the formula, revenue minus cost of goods sold, is also the formula for gross income. ...
  2. Gross Income – Expenses = Net Income. ...
  3. Total Revenues – Total Expenses = Net Income.
Feb 23, 2024

What is the formula for the gross net profit ratio? ›

Here, we will calculate the gross profit by subtracting COGS from revenue. Divide gross profit by revenue. Then, multiply this by 100 to find out the gross profit ratio.

What is the formula for net operating profit ratio? ›

Operating profit = Net sales – (Cost of goods sold + Administrative and office expenses + Selling and distribution exp.) Since, the operating profit ratio is expressed as a percentage, therefore we need to multiply by 100, the value obtained by the division of operating profit with the net sales.

Top Articles
ETFs for beginners | justETF
Why Is Acrylic Yarn Bad For The Ocean?
Durr Burger Inflatable
Katie Pavlich Bikini Photos
My E Chart Elliot
Combat level
Ixl Elmoreco.com
Gabriel Kuhn Y Daniel Perry Video
South Park Season 26 Kisscartoon
Air Canada bullish about its prospects as recovery gains steam
Mr Tire Prince Frederick Md 20678
Sportsman Warehouse Cda
Graveguard Set Bloodborne
Mivf Mdcalc
Shooting Games Multiplayer Unblocked
Identogo Brunswick Ga
Uhcs Patient Wallet
Top tips for getting around Buenos Aires
24 Hour Walmart Detroit Mi
Studentvue Columbia Heights
Sony E 18-200mm F3.5-6.3 OSS LE Review
Curtains - Cheap Ready Made Curtains - Deconovo UK
Imagetrend Inc, 20855 Kensington Blvd, Lakeville, MN 55044, US - MapQuest
Whitefish Bay Calendar
Craigslist Southern Oregon Coast
Mychart Anmed Health Login
Apple Original Films and Skydance Animation’s highly anticipated “Luck” to premiere globally on Apple TV+ on Friday, August 5
Sullivan County Image Mate
The Tower and Major Arcana Tarot Combinations: What They Mean - Eclectic Witchcraft
Jeff Nippard Push Pull Program Pdf
Chime Ssi Payment 2023
Watson 853 White Oval
Truvy Back Office Login
Gillette Craigslist
Taylored Services Hardeeville Sc
Emuaid Max First Aid Ointment 2 Ounce Fake Review Analysis
Winterset Rants And Raves
The value of R in SI units is _____?
Human Unitec International Inc (HMNU) Stock Price History Chart & Technical Analysis Graph - TipRanks.com
Envy Nails Snoqualmie
Skyrim:Elder Knowledge - The Unofficial Elder Scrolls Pages (UESP)
Can You Buy Pedialyte On Food Stamps
Tugboat Information
3496 W Little League Dr San Bernardino Ca 92407
Birmingham City Schools Clever Login
Bill Manser Net Worth
Anthem Bcbs Otc Catalog 2022
My Eschedule Greatpeople Me
Reli Stocktwits
Diesel Technician/Mechanic III - Entry Level - transportation - job employment - craigslist
Southern Blotting: Principle, Steps, Applications | Microbe Online
Latest Posts
Article information

Author: Laurine Ryan

Last Updated:

Views: 6234

Rating: 4.7 / 5 (77 voted)

Reviews: 92% of readers found this page helpful

Author information

Name: Laurine Ryan

Birthday: 1994-12-23

Address: Suite 751 871 Lissette Throughway, West Kittie, NH 41603

Phone: +2366831109631

Job: Sales Producer

Hobby: Creative writing, Motor sports, Do it yourself, Skateboarding, Coffee roasting, Calligraphy, Stand-up comedy

Introduction: My name is Laurine Ryan, I am a adorable, fair, graceful, spotless, gorgeous, homely, cooperative person who loves writing and wants to share my knowledge and understanding with you.