Net profit margin
Strategic perspective
Financial perspective
Key performance question this indicator helps to answer
How much profit are we generating for each dollar in sales?
Why is this indicator important?
With the previous KPI we looked at net profit as a total number. In order to make net profits more comparable and to understand how much profit a company makes for each dollar in revenue we can produce the net profit margin (also referred to as return on sales or net income margin), which takes the net profit of a company as a ratio over its total sales or revenues.
The net profit margin is therefore a key indicator of how well a company is run (i.e. how efficient it is and how well it controls its costs), as a low net profit margin could indicate too high operating costs or a wrong pricing structure.
Low net profit margins mean that a company has a lower ‘margin of safety’ and that small changes such as a slight decline in sales or a rise in operating expenses, e.g. higher fuel or electricity bills or a hike in raw material prices, could quickly diminish any returns and turn the company from a profitable business to a loss-maker.
For managers, net profit margins are particularly useful when compared over time and relative to other companies in the same sector. Investors often compare net profit margins across industries to identify the most profitable and attractive sectors and companies to invest in.
How do I measure it?
Data collection method
The data for the net profit margin metric are collected from the income statement (see previous KPI).
Formula
Frequency
Usually measured each month as part of the income statement preparation.
Source of the data
The net profit and revenue data are extracted from the accounting data.
Cost/effort in collecting the data
The costs of producing the net profit measure are usually low as long as a company has the relevant accounting information available. As most companies hold this data in existing accounting systems it is just a matter of adding a calculation routine to the existing system.
Target setting/benchmarks
Net profit margins vary by industry, but all else being equal, the higher a company’s profit margin compared to its competitors, the better. As a very general ball-park benchmark (which will depend a lot on the industry), a net profit margin of between 20% and 40% is considered to be very good. Here are some examples of the most profitable companies in the S&P 500 (a listing of the biggest and best public companies in America):
- Public Storage (NYSE:PSA) = 46.14%
- Corning Incorporated (NYSE:GLW) = 45.65%
- Altera Corporation (NASDAQ:ALTR) = 40.97%
- Linear Technology Corporation (NASDAQ:LLTC) = 39.14%
- CME Group Inc. (NASDAQ:CME) = 37.20%
The average net profit margin for all S&P 500 companies is around 10%.
Example
In the previous KPI description we calculated the net profit and net sales revenues for Grande Corporation based on its income statement (see pages 5–6).
To get to the net profit margin we simply divide the two numbers as follows:
Tips/warnings
As with net profits, net profit margins can also be measured by business unit or even by product or service, which often gives more interesting insights.
References
www.investopedia.com/terms/p/profitmargin.asp
www.in-business.org.uk/formula-for-calculating-net-profit-margin/
www.ccdconsultants.com/documentation/financial-ratios/net-profit-margin-interpretation.html