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How to Use the Net Profit Margin Profitability Metric

The most common measure of a company’s profitability is the net profit margin. This metric measures the percentage difference between net income and net sales. In other words, it measures the percentage of a company’s sales revenues that don’t go toward business costs. You measure profit margin like this:

image0.jpg

Here’s how to use this equation:

  1. Find net income near the bottom and net sales near the top of the income statement.

  2. Multiply net income by 100.

    You use the number 100 here to form an answer that’s a percentage rather than a decimal number.

  3. Divide the answer from Step 2 by net sales to get the net profit margin as a percentage.

The net profit margin tells you what percentage of the total money made by a company increases the value of the company or its owners rather than being spent on costs. However, a low profit margin doesn’t necessarily mean low profits.

A company with a 1 percent profit margin makes less money on every sale than a company with a 2 percent profit margin, but the company with a 1 percent profit margin may make up the difference with a greater volume of sales.

Note: Many texts say to divide net income by net sales and then multiply the answer by 100. Don’t worry, my preceding equation gives you the same answer. Test it for yourself or go ask your math teacher.

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