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Net Profit Ratio - Accounting. Tools. Overview. The net profit percentage is the ratio of after- tax profits to net sales.
It reveals the remaining profit after all costs of production, administration, and financing have been deducted from sales, and income taxes recognized. As such, it is one of the best measures of the overall results of a firm, especially when combined with an evaluation of how well it is using its working capital. The measure is commonly reported on a trend line, to judge performance over time. It is also used to compare the results of a business with its competitors. Net profit is not an indicator of cash flows, since net profit incorporates a number of non- cash expenses, such as accrued expenses, amortization, and depreciation. The formula for the net profit ratio is to divide net profit by net sales, and then multiply by 1. The formula is: (Net profit / Net sales) x 1.
The measure could be modified for use by a nonprofit entity, if the change in net assets were to be used in the formula instead of net profit. Example of the Net Profit Ratio For example, the Ottoman Tile Company has $1,0. CGS) of $5. 50,0.
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The income tax rate is 3. The calculation of its net profit percentage is: $1,0. Sales - $4. 0,0. 00 Sales returns = $9. Net sales$9. 60,0. Net sales - $5. 50,0.
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CGS - $3. 60,0. 00 Administrative = $5. Income before tax$5. Income before tax x (1 - 0. Profit after tax($3. Net sales) x 1. 00 = 3.
Net profit ratio. Issues with the Net Profit Ratio. The net profit ratio is really a short- term measurement, because it does not reveal a company's actions to maintain profitability over the long term, as may be indicated by the level of capital investment or expenditures for advertising, training, or research and development. Also, a company may delay a variety of discretionary expenses, such as maintenance, to make its net profit ratio look better than it normally is. Consequently, you should evaluate the net profit ratio alongside a variety of other metrics to gain a full picture of a company's ability to continue as a going concern.
Another issue with the net profit margin is that a company may intentionally keep it low in accordance with a low- pricing strategy that aims to grab market share in exchange for low profitability. In such cases, it may be a mistake to assume that a company is doing poorly, when in fact it may own the bulk of the market share precisely because of its low margins. Conversely, the reverse strategy may result in a very high net profit ratio, but at the cost of only capturing a small market niche. Another strategy that can artificially drive down the ratio is when a company's owners want to minimize taxes, and so accelerate the recognition of taxable income into the current reporting period. This approach is most commonly found in a privately held business, where there is no need to impress outside investors with the results of operations. Similar Terms. The net profit ratio is also known as the profit margin. Similar Ratios. Contribution margin.
Contribution margin ratio. Gross profit ratio.