The net profit margin ratio is a profitability ratio that is a margin ratio. It can be calculated by using numbers off the company's income statement. Net profit margin is the number of dollars of after-tax profit a firm generates per dollar of sales. If a firm generates $1.00 of sales revenue, for example and has a 5 percent net profit margin, that means it generated 5 cents of profit.
Net Profit Margin Ratio = Net Income/Net Sales = ________%
Net sales is simply sales revenue with any returns and allowances subtracted out. Net Income is income with all expenses subtracted out including taxes, interest expenses, and depreciation. It is the "bottom line."
How Companies use the Net Profit Margin Ratio
Net profit margin indicates how well the company converts sales into profits after all expenses are subtracted out. Since industries are so different, the net profit margin is not very good at comparing companies in different industries. It is good, however, at comparing companies in the same industry if you want to look at the bottom line.
It is also a good time-series analysis measure whereby business owners can look at data for their own company across different time periods to see how the net profit margin is trending. Financial ratios are only useful when comparative analysis is used.
Company's that generate greater profit per dollar of sales are more efficient. When you look at the net profit margin ratio, you see that the numerator (net income) is affected by the company's actions to reduce expenses and the denominator (net sales) is affected by the company's actions to increase sales revenue. Both actions will increase the net profit margin ratio.