Following our articles looking at business analysis, we turn to the net profit ratio (NPR). In business, we also often refer to this ratio as the Net Profit Marin. Rather than looking at return on investment or funds employed, the NPR looks at how much of a firm’s revenue it retains after expenses but before tax and interest.
The Net Profit Before Interest and Tax (NBIT) is generally used in the calculation because interest costs are related to the funding structure of the business and taxes; in this business, income tax, the firm has little control over. Instead, the ratio focuses on the profitability of the business’s core operations rather than from earnings from investments, borrowing costs, or the jurisdiction’s tax policy.
Net Profit Formula
Net Profit Ratio = (Profit Before Interest and Tax / Sales) x 100
You have extracted the following data from the statement of financial performance for the company you wish to analyse:
- profit before interest and tax = $250,000
- sale = $500,000
This would produce a NPR of 50%: ($250,000 x 100) / $500,000
Like all such analyses, you must view the percentage figure within the context of that particular business. For example, an NPR of 50 per cent in some industries would be high, yet in others, it would be average. The figure also lacks context without knowing the firm’s performance over time; what is its overall trend? And, if there is a significant change in that trend, what might be causing this?
When writing this tutorial, the worldwide economic slowdown and recession are dramatically impacting many firms’ NPRs. But a firm with a good track record, healthy returns on sales over time, low debt and good management should see a reversal in this ratio back towards its average.
Net Profit Calculator
Below is a simple calculator to further help in understanding the NPR calculation. Try some different figures to see how changes in sales and expenses impact a firm’s NPR.