What is net profit? (And how to calculate it with examples)

By Indeed Editorial Team

Published 30 March 2022

Net profit margin is an important metric that companies use to calculate the profitability of their business and is especially useful in comparing your profitability with other companies, regardless of their size. Investors look at net profit margins to establish if a company is profitable and whether their business model is sustainable. Learning how to calculate net profit margin is essential if you wish to improve as a manager or business leader. In this article, we answer the question 'What is net profit', how you can calculate it and some helpful examples.

What is net profit margin?

To understand the answer to the question 'What is net profit margin?', you can look at what calculating the net margin does for companies. Net profit margin or just net margin, measures the amount of profit that a company makes as a percentage. While it's usually presented as a percentage, you can also show it as a decimal. The net margin helps to illustrate the amount of profit made per euro of revenue earned. This is one of the most important factors that indicates success for a company. Here is the formula for calculating the net profit margin:

Net profit margin = (net profit/revenue) x 100

Net profit is a valuable asset for attracting outside investors and funding. Many investors look at a company's net profit to see if the company is viable. A healthy net profit shows that a company is profitable while maintaining its overhead and operating costs, such as rent, production costs and salaries. By tracking the increases and decreases in net profit, investors and companies can see whether their current business models, products and sales are working the way the company might want. It can also help to predict future revenues and market trends.

Related: What is variable cost vs fixed cost (with examples)?

How to calculate net profit

There are a few steps that you can follow to calculate your net profit margin. Make sure to do your research and find all the numbers and statistics that you need before you begin your calculation. Providing an accurate answer when calculating your net profit is important, so remember to re-check your calculations and ask a friend if you aren't completely sure. Here are the steps that you can take to find your net profit margin:

1. Calculate your net profit

If you want to determine your net profit, locate the total revenue of your company on an income statement. Net profits are the profit that you make once you have deducted all the costs, such as production costs, operating costs, interest, taxes and any other deductions. Then subtract these from your revenue. It's a good idea to make a list of all the costs associated with your products before you begin your calculations and keep a list of these separate from the formula. This is what it might look like in a formula:

R- OC - PC - I - T - E = net profit

R= revenue

OC= operating costs

PC = production costs

I = Interest

T = taxes

E = all other expenses.

2. Divide net income by revenue and multiply the result by 100.

Take the number that you found in step one and divide it by the total revenue figure. To get your answer as a percentage, which is standard when you're finding the net margin, multiply your answer by 100. The answer reflects the profitability of the company and its ability to control costs such as overhead and operating costs. A high net margin is usually a good indicator of this, while a low net margin might reflect inefficiencies within your company's business model. A low net margin can indicate high production costs, ineffective marketing or bad product pricing.

While a low net margin can be a bad indicator, it can also be a conscious choice taken by a company. A lower net margin might reflect a long-term strategic decision on behalf of the company. As an example of this, a company might offer a product at lower prices if they want to attract a higher volume of consumers. Net margins can increase or decrease a large amount in a short amount of time and a pricing war between competitors, with each company offering lower and lower prices, can certainly result in a lower net margin.

When to use net profit margin

You can use the net profit formula for a number of different situations. The main reason that you might calculate your net margin is to find out if your company is generating enough profits and if you can manage the current costs associated with running the business. Knowing the costs associated with managing your business is extremely important. Calculating your net margin can give you a clear idea of your profits and your costs and is extremely helpful in planning for the future. Here are some other ways you can use your net profit margin formula:

Predicting profits

This formula can help you to predict future profits based upon your current financials. When you find your net profit, you can use that information to make informed decisions about your company's future and how you might grow these profits. Being able to predict your future revenue is extremely important for allocating funds and planning future projects.

Comparing profits

You can use your net margin to compare your profitability with similar companies. Comparing your profitability with other companies can help you see what areas you can improve in or in what areas you might be more ahead of your competitors. You can use your net margins to compare companies regardless of their size, so it can help you find the industry standard and take the steps you can to achieve it.

Attracting investors

Showing a great net profit is great for attracting new investors. Investors use figures like your net margin to decide whether your company is profitable. If an investor likes what they see, they are more likely to invest in your company. When you attract more investment, you have more capital to pursue projects and use funds to help improve and develop your company.

Related: What is capital (with definition, types, uses and markets)?

Net profit margin vs gross profit margin

The gross profit margin of a company is the income that remains after subtracting the costs of the goods that the company sells. These only include the costs that are directly related to the manufacturing of the project and don't include other things such as rent, utilities and salaries. The difference between these two things is that the net profit margin of a company does include all of these different expenses. Calculating the net margin gives a better overall view of the company's success and profitability.

Related: What are fixed costs (definition, importance and examples)?

Examples

A company may decide to calculate the net margin for many different reasons. Here is an example of a situation where they might do this:

John's Shirts, a clothes shop, sold 100,000 shirts for €5 each, with a cost of goods sold for €2 per shirt. John's Shirts had €50,000 in operating expenses and paid €15,000 in taxes.

If you want to calculate the net profit of John's Shirts, you start by finding their revenue. If John's Shirts sold 100,000 shirts at €5 each, the total revenue generated from these sales is €500,000. The cost of goods sold was €2 per shirt, which in turn means that the total cost of goods is €200,000.

This means that the total gross profit is €300,000. The formula for this looks like:

€500,000 revenue - €200,000 cost of goods sold = €300,000 gross profit made.

Now you can subtract the operating costs from the gross profit made, which means that you have €250,000 in income before you pay any taxes. Once you have done this, you can subtract the €15,000 in taxes that you have paid.

€250,000 - €15,000 = €235,000

Using all this information in your net margin formula looks like this:

€135,000 net profit / €500,000 revenue = .47

Once you multiply this by 100 you get a number of 47%. This is your net profit margin. It's very important to make sure that all the figures that you're entering into this figure are correct as even the smallest mistake can make your answer incorrect. It's a good idea to check your net margin regularly as it can help you to see when your company is at its most profitable and successful.