The net profit ratio (also known as net profit margin) is the net profit after tax as a percentage of net sales. The formula to calculate the net profit (NP) ratio is: Both the components in this formula—net profit and net sales—are usually found in the trading and profit and loss account or income statement. The net profit ratio, taken together with the return on equity (ROE) ratio, shows how well the company marks up its goods for sale and how well it manages to contain its indirect expenses within the gross profit margin. As explained in the gross profit ratio, certain companies with heavier overheads need to have a higher gross profit margin. If we take gross profit as a percentage of sales (gross profit ratio) and then relate it to net profit as a percentage of sales (net profit ratio), we can evaluate the efficacy of a company's pricing policy. If a high gross profit margin does not translate into an adequate net profit percentage, one of the reasons why could be that higher prices are affecting the sales volume. As a result, the overall profit is dropping. The other reason could be that the indirect expenses (i.e., overheads) are too high in relation to the volume of business handled. The following information was extracted from the accounting records of John Trading Concern: Required: Calculate the company's net profit ratio. NP ratio = ($480,000*/$4,800,000**) × 100 = 10% *Net profit after tax = 960,000 × 0.5 = $480,000 **Net sales = $4,850,000 - $50,000 = $4,800,000 John Trading Concern's net profit ratio is 10%. For a trading company, that's generally a good return on sales. However, a true evaluation of management's efficiency in generating a return on sales is possible only when this ratio is compared along with others relevant to the industry, or with the industry's average net profit ratio. [show_file file="webcalculators/ratios/net-profit-ratio.txt"]Net Profit Ratio: Definition
Net Profit Ratio: Formula
Net Profit Ratio: Example
Solution
Interpretation
Net Profit Ratio Calculator
Net Profit Ratio FAQs
Net profit is calculated as revenues less all expenses, which include cost of sales, salaries, interest on loans taken for business operations, rent paid for premises used in business operations etc. Net sales, on the other hand, is simply sales less any returns and discounts.
Gross profit (GP) represents the difference between selling price per unit and cost of goods sold per unit. At the same time, the net profit margin is how much money the company generates for every dollar in sales. Net profit is calculated by deducting all expenses from total revenue.
Companies that have higher degrees of specialisation can afford to have a lower gross profit margin because they are able to produce more products at a lower cost. Software companies, for instance, often have high gross margins because they can create a single product and then sell it to a larger market.
Companies prefer to report gross profits because it gives a better indication of the company's overall profitability. It is more useful to know how efficient a business is in generating revenues from their own products and services, compared with looking at earnings after all expenses have been deducted.
They are related, but opposite ideas. Gross margin represents the ratio of gross profits over total revenues for a company; net margin denotes the ratio of net profits over total revenues.
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.
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