As an investor or business owner, you will probably be very interested in the two terms Revenue and Profit. Because, Revenue and Profit are two important factors that help reflect whether the business is operating effectively or not. In there, Net Profit Margin – an extremely important profit measure that investors absolutely cannot ignore. So Net Profit Margin what? How is it calculated?

In the following article, lamchutaichinh.vn will provide you with the most complete knowledge about net profit margin.

What is Net Profit Margin?

Net profit margin in English is Net Profit Margin/ Net Margin means net income or profit after tax as a percentage of sales.

More specifically, when the company operates effectively, they will achieve high net income. Conversely, if profit after tax is lower than revenue growth, the net profit margin will decrease, indicating that the company is operating inefficiently.

In essence, the term is viewed as a ratio of net profit to net sales of a company or business division.

What is Net Profit Margin?
What is Net Profit Margin?

In other words, Net Profit Margin is the illustrative index of how much profit after tax will be in one dollar of revenue of the business. It is usually expressed as a percentage but can also be expressed as a decimal.

Net profit margin Also known as net profit margin. The phrase “Net Profit” is equivalent to “Net Income” in the financial statement, and the two terms are often used interchangeably.

Meaning of Net Profit Margin

  • Helping investors evaluate and compare companies in the same industry regardless of size to see the business performance and competitiveness of companies with each other.
  • Measures how much net income is generated as a percentage of sales achieved.
  • Play the most important role in reflecting the “financial health” and profitability of the company by monitoring the change of Net Profit Margin. From there, the company will consider whether the current business plan is effective or not and make a profit prediction based on revenue.
  • Used to replace the indicator “Net profit” to evaluate the financial situation, the efficiency in the consumption and sale of goods and services of the company.

Formula to calculate Net Profit Margin

We can calculate the Net Profit Margin using the following formula:

Net Profit Margin = (Profit after tax/Net revenue) x 100%

In there:

Profit after tax: the amount remaining after taking total revenue minus total costs for production, business and income tax of the company.

Eg: Profit after tax = Total revenue – Cost of goods – Operating expenses and other expenses – Taxes – Interest.

Net Revenue: the amount the company earns from the sale of goods and services after deducting taxes (import-export taxes) and discounts (trade discounts, rebates, ..)

Formula to calculate Net Profit Margin
Formula to calculate Net Profit Margin

Eg: Net Sales = Total Sales – Sales Discounts – Refunds – Discounts – Indirect Taxes.

We can calculate Net Profit Margin by fiscal year or by quarter to clearly see the profitability of the company in each period.

In fact, there are 2 ways to calculate Net Profit Margin as follows:

  • Way 1: Get directly through the available metrics.
  • Way 2: Calculated based on financial statements.

Usually, companies will choose option 2 because the figures used to calculate net profit margin are often located in the income statement section of the financial statements. As a result, companies can save calculation time.

However, lamchutaichinh.vn encourages you to calculate directly through the available data a few times. There will be many hidden problems behind this indicator, which we will cover in the next section.

Example how to calculate net profit margin based on financial statements

In the following, we will read Vinamilk’s business results in 2019, and based on this report to calculate Net Profit Margin in 2019 as follows:

Business results report of Vinamilk
Business results report of Vinamilk

Based on the report we have the following data:

  • Net revenue in 2019 (row 2, column 4): 59,318 billion VND
  • Profit after tax: 10,554 billion VND
  • Thus, NPM = (10,554 : 59,318) x 100 = 17.79%

This means that out of 100 VND of revenue, Vinamilk earned 17.79 VND of profit after tax.

Elements of net profit margin in all business activities

Elements of the net profit margin in all business activities include:

  • Total revenue of the company
  • All outgoing cash flows (production costs, maintenance costs, labor rents, space rentals, etc.)
  • Additional income stream
  • Cost of goods sold and other operating expenses
  • Debt payments including interest paid
  • Investment income and income from secondary activities
  • One-time payments for extraordinary events such as lawsuits and corporate taxes.

Factors affecting the net profit margin index

Operating costs

The higher the operating costs, the lower the profit, of course. Therefore, if the business has to spend a large operating cost, the Net Profit Margin index will be smaller. Therefore, in order to have a large net profit margin, the company needs to find ways to optimize operating costs.

Input cost

Input prices of goods/services also play a decisive role in the company’s operating costs. When this cost is optimized, the company’s net profit will be larger. Therefore, when doing business, companies should look for many different suppliers, in order to optimize input costs to the lowest.

Business tax

According to the Law, corporate tax is the responsibility and obligation of each company. Therefore, this is a fixed cost, which cannot be optimized.

Limitations of using net profit margin

Limitations of using the Net Profit Margin indicator
Limitations of using the Net Profit Margin indicator

Huge limitations when investors use Net Profit Margin index to evaluate companies.

Only effective when comparing companies in the same industry

In fact, the net profit margin is only suitable for comparing companies in the same industry. Because each industry, field will have different characteristics that create a distinct difference in both revenue and profit.

Eg: Companies in the cosmetics industry in 2020 may report high profits but low sales. While the financial statements of a company in the food industry for 2020 show lower profit margins and higher sales.

Therefore, we cannot compare the Net Profit Margin index between the aforementioned companies, then draw conclusions about which company is more efficient. We should only compare companies in the same industry with similar business models.

It is best to use financial metrics to analyze a company. This metric is often used in financial analysis along with gross margin and operating margin.

Should not be used to make an independent review

A low net profit margin of a company does not mean that the company is underperforming, and a high net profit margin does not mean that the company has high cash flow.

Net Profit Margin does not rely on sales or revenue growth and does not provide insight into whether management is effectively managing the production process.

Therefore, it is difficult to assess the company’s performance by the net profit margin index. Investors need to combine many other financial indicators to ensure high efficiency.

How to effectively improve the net profit margin for the business?

How to improve net profit margin
How to improve net profit margin

Increase net profit margin by increasing gross profit margin

Improving net profit margin through increasing sales is the most popular option. Businesses can increase their sales income by increasing the prices of goods or selling more types and quantities of goods.

However, businesses must be very wary of customers saying no to “heavenly” prices and consider customer needs. Because, if demand for that commodity isn’t high enough, an untimely increase in production and cost can dramatically increase the inventory of depreciated value in the warehouse.

Increased net profit margin thanks to reduced related costs

Every day, each business has to bear a huge cost to maintain operations from renting premises, hiring workers, corporate taxes, etc.

Therefore, to be able to reduce costs and increase the net profit margin can be done by moving the business headquarters to a cheaper area or reducing the unnecessary workforce. However, it is still necessary to ensure the quality of the goods and the progress of the work.

In addition, to reduce costs is to find cheaper sources of production materials. These actions may reduce the quality of the goods when they are sold in the market. Therefore, businesses need to pay special attention to this issue.

To reduce production costs without compromising quality, the best option for many businesses is to scale. Scaling up production can be an effective long-term strategy to improve net profit margin. This will help drive more sales volumes and reduce the average cost per product manufactured.

Conclude

In the above post, lamchutaichinh.vn has revealed to you extremely useful knowledge on the topic “Net Profit Margin”. Please refer and apply it well in your investment.

Please continue to follow our website to update more interesting investment knowledge. Good luck!


 


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