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Net Profit Margin

First some basic profitability equations:

Remember:

Net Profit = Gross Profit - Expenses

Why do we have two versions of this ratio - one for net profit and the other for profit before interest and taxation? Well, in some cases, you will find they use the term net profit and in other cases, especially published accounts, they use profit before interest and taxation. They both mean the same: look back at the financial statements for Tesco where we compared different names for the same things.

The net profit margin ratio tells us the amount of net profit per £1 of turnover a business has earned. That is, after taking account of the cost of sales, the administration costs, the selling and distributions costs and all other costs, the net profit is the profit that is left, out of which they will pay interest, tax, dividends and so on.

Here are a few examples of the net profit margins from the same businesses we saw in the gross profit margin section:

Just like the gross profit margins, the net profit margins also vary from business to business and from industry to industry. When we compare the gross and the net profit margins we can gain a good impression of their non-production and non-direct costs such as administration, marketing and finance costs.

We saw that the international airline's gross profit margin was the lowest of this group of eight businesses at only 5.62%; but look, its net profit margin is 4.05%, only a little bit lower than its gross profit margin. On the other hand, the discount airline's gross profit margin is 27.46% but its net profit margin is a lot less than that at 10.87%. As we just said, these comparisons give us a great insight into the cost structure of these businesses.

Look at the software business too, a very high gross profit margin of 89.55% but a net profit margin of 27.15%. This is still high, but we can now see that the administration and similar expenses are very high whilst its cost of sales and operating costs are relatively very low.

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