Another type of profitability ratio for assessing the profitability of a company is:
The NET PROFIT MARGIN
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FORMULA |
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Net Profit After Taxes / Net Sales |
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MEASURE WHAT |
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Indicates overall business profitability. Shows how effective managers run the business. |
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SCORE OR VALUE |
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Approx 10-20% is good. Higher is better >8% Strong >6% Acceptable <4% Evidence of weakness <2% Weak <0% Problems present |
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SALIENT POINTS TO NOTE: |
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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. |
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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. |