Net Profit

Look at the following example:

In the profit statement above, the business has made a net profit of £50,000. The net profit is calculated by subtracting all the business costs (£150,000) from the total sales of £200,000. In the period, the business has made a net profit margin of 25%. That means that it has converted 25% of each pound of sales into profit – a good achievement.

The net profit margin tells us something about how well a business is able to convert sales into profit. It is an important measure of relative profitability. Here is how it is calculated:

Note: net profit margin is expressed as a percentage.

What does the net profit margin tell us?

• How effectively a business turns its sales into profit
• How efficiently a business is run (in particular, is it keeping its operating costs as low as it can)
• Whether a business is able to “add value” during the production process (a high margin business must be doing something right!)

On its own, the net profit margin is useful information. However, it is even more useful if comparisons can be made between:

• Changes in net profit margin over time (e.g. month by month or comparing years)
• Net profit margins of competitors in the same market

Look at this example below:

Looking at the financial information in the table above, you can see that:

• Company A makes a higher net profit than Company B even though its sales are lower – because it has a higher net profit margin
• Company C makes the highest net margin of these three & also the highest sales. So it makes the largest net profit too