Definition: The Net Profit Margin Ratio shows the net income earned from the sale of goods and services or simply, how much profits are generated at a certain level of sales. This ratio shows the earnings or the revenues left for the shareholders, both equity and preference shareholders, after making the payment of all the operating expenses, interest, taxes, etc.
The net profit margin is all about how much a company can save from the sale of one unit. The overall success of the company can be measured by this ratio. The high value of net profit margin ratio shows that the company is following the correct pricing policy and is efficiently controlling the cost of production.
To assess the performance of the company, its net profit margin should be compared with the other companies within the same industry since these will have the same business environment and the common customer base. The formula to compute this ratio is:
Net Profit Margin Ratio = Profit after tax/Net Sales
Higher the ratio, better is the ability of a firm to pay a profit share to the shareholders and pay off the loans taken from the creditors.
Example: Suppose a firm has net sales of Rs 3,00,000, and the net profit is Rs 30,000. Then the net profit margin ratio will be:
Net Profit Margin Ratio = 30,000/3,00,000 = 0.1 or 10%