How to Calculate Net Profit Margin
However, there are variations of the formula that are often used by analysts and managers, particularly where there is a need to determine what the net margin would be if there was no taxation and interest payment to make. The variations of the formula are important especially since companies face different tax structures and financial obligations. In such cases it is necessary to add interest and taxation charges back to the net profit figure, or simply use the “Profit before Interest and Taxation" number.
Lets look at an example. Assuming that XYZ generates sales of $100,000 with cost of goods sold of $40,000, what would the net profit margin be if XYZ has administrative expenses of $10,000, taxes charges of $5,000 and interest expenses of $2,000?
First, let us calculate the profitability figures:
- Gross profit = sales – cost of good sold
- $100,000 – $40,000 = $60,000
Net profit = Gross profit – expenses- taxation -interest
- $60,000 - $10,000 - $5,000 - $2,000 = $43,000
Depending on the net profit margin method that is being used, the net profit margin is calculated as follows:
- (net profit/sales)*100
- 43% or 40cents on every dollar
- (net profit before interest and taxation/sales)*100
- 60,000 - 10,000 = 50,000
- 50% or 50cents on every dollar
These are pretty high figures, which would suggest that either the company has a very high quality product that customers are prepared to pay a premium for; there is little competition or XYZ is doing an outstanding job of controlling costs.