Net Profit and profitability
Net Profit = Total Revenue – Total Expenses
Profit can be elusive. It’s important to know as much as you can about how to look at the numbers to assess true profitability. Net profit margin is something else to look for.
Net profit margin
When you know your net profit, you can analyse net profit margin. It looks at net profit as a percentage of total revenue. In other words, it’s what proportion of revenue remains out of all revenue, after deducting operating expenses, interest, and taxes.
Net Profit Margin = Net Profit/Total Revenue = (Total Revenue – Total Expenses)/Total Revenue
Why is net profit margin important?
Net profit is your bottom line after all and some business owners might be content not to dig deeper. But if you don’t, you won’t know what percentage of revenue ended up in the bottom line. Shareholders and potential investors would be quite interested to know what it is because net profit margin says how effective your business is at taking revenue and making it into profits available to shareholders. If you’re trying to pitch your business to investors, net profit margin is a way to grab their attention.
Keeping an eye on changes in your net profit margin is also a great way to keep tabs on how profitable your business is over time.
How is net profit margin different from gross profit margin?
Let’s go back to basics. Profit margin is a percentage that tells you the amount a company earns per dollar of sales.
Gross profit margin shows your total revenue minus what it cost the business to produce the goods or services it sold. It’s the amount a company earns per dollar of sales after you deduct how much it cost to make the sale (aka cost of goods sold). It’s a broad brush indicator of profitability and you can use it to help you work out your breakeven point.
Because you can be making more money but not as much profit (if, for instance, your overheads or your taxes go up), net profit margin gives you the next level of detail to help you zero in on profitability. It factors in other expenses beyond the cost of sale.
Net profit margin shows your profit as a percentage of revenue, after all expenses have been deducted, including tax and any interest paid on money you owe. It is the percentage of revenue that actually reflects a company’s profit per dollar of sales. If you operate in a competitive market, bringing your costs down might be a better strategy than increasing your prices, especially if in the short term it’s hard to increase your market share. A better cost management strategy, consolidating your debts or finding a more favourable interest rate may all be worth considering.
Your bottom line remains all important. But squeeze it to make it tell you more so you can keep improving profitability in your business.
‘The secret to my success is that I bit off more than I could chew and chewed as fast as I could.’ Paul Hogan