When Dorothy, the Scarecrow, the Tin Man, and the Cowardly Lion arrived at the Emerald City to meet the Wizard, they were desperate to find “a brain, a heart, a home, and the nerve.”
Blinded by sparkly grandeur, they didn’t once stop to consider they might be getting scammed. How could anyone possibly give them these intangible items?
While the billions of dollars corporations bring in annually may wow shareholders like doe-eyed Dorothy, it is equally important they pay attention to expenses and taxes in addition to profit.
If we’re being realistic, net profit margin is a calculation every smart investor should know so as not to journey all the way to Wall Street only to find their stock depreciated.
What is net profit margin?
Net profit margin measures how much a company makes after all expenses are accounted for, compared to the company’s total revenue.
Net profit margin definition:
A percentage or decimal representing the amount of a company’s total revenue it retains after all costs and expenses are paid
You could think of net profit margin as how much of each dollar of revenue is retained by the company after they’ve paid off everything else—like interest expenses, taxes, paying employees, and raw materials.
In short, net profit margin is total earnings as a percentage of its revenue.
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What is a good net profit margin?
A good net profit margin, like most financial measurements, varies by industry and company. You can’t compare the net profit margins of two companies in vastly different sectors, like healthcare and food, and expect to learn anything about how they measure up to each other.
However, if you compare two companies with similar types of expenses, you might learn something about how tight of a ship they’re running. Net profit margin is a measure of efficiency and profitability. The higher the profit margin, the better. Companies looking to raise their net profit margins need to find a way to cut costs while maintaining the same revenue.
How do you calculate net profit margin?
Net profit margin is calculated using a company’s net income and total revenue—all data that can be found on its income statement. A company’s net income is its gross profit minus its cost of goods sold, or COGS. Rather than calculating it, you can always find net income at the bottom of the income statement.
Tip: Net income is also known as bottom line, because it appears at the bottom of an income statement.
Once you know a company’s net income and revenue, plug them into the equation below to find the net profit margin.
Net profit margin equation
Net profit margin = Net income / Revenue x 100
Net profit margin example
Let’s compare two similar companies’ profit margins to see who is more profitable: McDonald’s and Wendy’s.
Total revenue: $21,025,200,000
Net income: $5,924,300,000
Net profit margin = 5,924,300,000 / 21,025,200,000 x 100 = 28.18%
Total revenue: $1,589,936,000
Net income: $460,115,000
Net profit margin = 460,115,000 / 1,589,936,000 x 100 = 28.94%
Even though the McDonald’s net income is much higher than Wendy’s, their net profit margins are very similar. This means that even though one company is making more money than the other, they are similarly profitable, and Wendy’s, the smaller of the two, has a slight edge on McDonald’s when it comes to net profit margin.
This could be because McDonald’s pays their employees higher wages, or because Wendy’s uses cheaper supplies. We don’t know for sure by this calculation; most likely it is a combination of several factors.
Net profit margin vs. gross profit margin
Net profit margin is a more accurate measurement of a company’s profit margin. Gross profit margin tells you the profit margin of a company without accounting for taxes, COGS, interest, or other expenses.
Pull back the curtain
Instead of getting carried away with big numbers and gross profits, a simple calculation to find a company’s net profit margin can give you a more realistic picture of how a company is doing. It’s the least investors can do to find out more about profitability. However, if you’d rather not do the math yourself, investment portfolio management software can help.