Profitability Ratio: Net Profit Margin

June 8th, 2006 Comments off
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Another type of profitability ratio for assessing the profitability of a company is:

The NET PROFIT MARGIN

FORMULA

Net Profit After Taxes / Net Sales

MEASURE WHAT

Indicates overall business profitability. Shows how effective managers run the business.

SCORE OR VALUE

Approx 10-20% is good. Higher is better

>8% Strong

>6% Acceptable

<4% Evidence of weakness

<2% Weak

<0% Problems present

SALIENT POINTS TO NOTE:

1.     Comparing gross & net margins, we can get a good sense of its non-production & non-direct costs like general and administration, finance & marketing costs. E.g. in the software business: exceeding high gross margin of #90% but a net profit margin of 27%. This shows that its marketing & administration costs are very high while its cost of sales & operating costs are relatively low.

2.      High net margin means bigger cushion to protect themselves during hard times & reflects a competitive advantage to improve market share when things improve again.

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Financial Accounting

 
 

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