A further ratio that can be used in determining the profitability of the firm is the net profit ratio (NPR).
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, are accounted for.
Net Profit Ratio Formula
Net Profit Ratio = (Profit Before Interest x 100) / Sales
Net Profit Ratio Example
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 net profit ratio 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.