A further ratio that can be used in determining the profitability of the firm is the net profit ratio (NPR). This ratio is also often referred to as the Net Profit Marin.
The ratio, rather than looking at the return on investment or funds employed, looks at how much of a firm’s sales are retained within the business after all expenses, before tax and interest, are accounted for.
The Net Profit Before Interest and Tax (NBIT) is generally used in the calculation because interest costs relate to the funding structure of the business and taxes, in this business income tax, the firm has little control over. The ratio is rather focused on the profitability of the core operations of the business rather than from earnings from investments, borrowing costs, or the jurisdictions tax policy.
NPR = (Profit Before Interest and Tax x 100) / Sales
You have extracted the following data from the statement of financial performance for the company you wish to analyze:
- profit before interest and tax = $250,000
- sale = $500,000
This would produce a NPR of 50%: ($250,000 x 100) / $500,000
Net Profit Ratio Analysis
The percentage figure, like all such analysis must be viewed within the context of that particular business. For example, within certain sectors a NPR of 50% would be considered average, while in another exceptional. The figure also lacks context without knowledge of the firm’s performance over time; what is it’s over all trend? And, if there is a significant change in that trend what might be causing this?
At the time of writing this tutorial many firms’ NPRs are being dramatically impacted by the world-wide economic slow-down and recession. But a firm with a good track record, for example a healthy return on sales over time and in comparison with others in its sector, with 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 how the NPR calculation is made. Try some different figures so you can see how changes in sales and expenses impact on a firm’s NPR.