One of the most essential aspects of launching and operating a business is selling enough goods or services to pay for the company's costs. If a company can't earn enough to cover its costs, it loses money, which may eventually force owners to shut the company down. Net profit margin or net profit ratio is a value that measures a company's profitability, which can help managers analyze company performance.
Net Profit Margin Basics
Net profit margin is the percentage by which a company's total sales or revenue exceeds or is less than the sum of its expenses. If a company has a positive net profit margin during a certain period of time, it means the company made more money during that period than it spent whereas a negative net profit margin means the company spent more money than it made.
Calculating Net Profit Margin
Net profit margin is calculated by subtracting total cost from total sales and then dividing the result by total sales. For example, if a business has $1 million in total sales and its total costs equal $800,000, its net profit margin is $200,000 divided by $1 million or 20 percent.
Net profit margin essentially measures the amount of each dollar of sales that a company has left over after it pays all of its expenses. For instance, if a company has a net profit margin of 20 percent, it means the company makes 20 cents of profit for each dollar of sales. A high net profit margin means a company is able to control its costs that buy goods and services at prices significantly higher than it costs to produce or provide them.
A company with a low or negative net profit margin can potentially increase its profitability by taking steps to reduce costs and increase sales. Cost-cutting measures such as producing goods more inexpensively, laying off workers and shutting down nonperforming projects can help boost net profit margin. Similarly, altering the price of a product or service or improving advertising or distribution could potentially increase sales and lead to a higher net profit margin.
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