Net profit margin:
what you keep from every ₹100 of sales

What net profit margin tells you

Net profit margin is the percentage of your revenue that is left after every cost has been paid: the goods or services you sold, salaries, rent, marketing, interest, depreciation and tax. It is the bottom line expressed as a share of the top line.

A ₹10 margin on ₹100 of sales is the same 10% whether the business turns over ₹5 lakh or ₹5 crore. That is what makes the ratio useful for comparing one year with another, or one business with a similar one.

It differs from gross margin, which stops after the direct cost of the product. Net margin keeps going, so it captures overspending that gross margin cannot see.

Do not confuse the margin with net profit itself. Net profit is a rupee amount; net profit margin is that amount divided by revenue, which lets you compare periods of different size.

Net profit margin formula

The calculation is a subtraction followed by a division, and the hard part is collecting complete cost figures. Use the profit and loss statement from your accountant or accounting software, and make sure nothing is missing.

1. 1Start with revenue for the period, excluding GST.
2. 2Subtract direct costs to get gross profit.
3. 3Subtract operating costs: salaries, rent, software, marketing and depreciation.
4. 4Subtract interest to reach profit before tax, then subtract tax to reach net profit.
5. 5Divide net profit by revenue and multiply by 100.

Example: a digital agency's year

A small agency had revenue of ₹48,00,000. Its costs before tax were ₹41,40,000, made up of ₹18,00,000 in freelancer fees, ₹14,40,000 in salaries, ₹4,20,000 in rent and software, ₹3,00,000 in marketing, ₹1,20,000 in depreciation and ₹60,000 in loan interest. For illustration, assume tax of 25% of profit before tax.

The agency keeps about ₹10.31 of every ₹100 it bills. That is the figure to compare year on year, and the one a lender or buyer will look at first.

Where each ₹100 of revenue goes

Walking down the profit and loss statement shows how each cost group eats into the revenue. Every row below is shown as a share of the same ₹48,00,000.

Put another way, each ₹100 billed goes ₹37.50 to freelancers, ₹30 to salaries, ₹8.75 to rent and software, ₹6.25 to marketing, ₹2.50 to depreciation, ₹1.25 to interest and about ₹3.44 to tax. The remaining ₹10.31 is the net profit.

The biggest drop is between gross profit and operating profit, where salaries, rent, marketing and depreciation together take 47.5 percentage points of revenue. That is where a margin improvement is most likely to be found.

When revenue grows but profit does not

Margin can fall in a year when sales rise. Suppose revenue grows 10% to ₹52,80,000 while costs before tax rise 12% to ₹46,36,800.

Profit before tax is then ₹6,43,200. After the same assumed 25% tax, net profit is ₹4,82,400, and the margin is 9.14%. The agency billed ₹4,80,000 more but kept ₹12,600 less.

The effect is sharper if revenue stays flat. The same 12% rise in costs against unchanged revenue of ₹48,00,000 leaves profit before tax of ₹1,63,200, net profit of ₹1,22,400 and a margin of just 2.55%. A cost rise of a few percentage points can wipe out most of the margin of a business that earns 10%.

This is why net margin is a better yardstick than revenue growth. A business that grows faster than it can control its costs is working harder for less.

How to use the number once you have it

There is no single healthy net margin. Retailers, contractors and software firms run on different cost structures, so the most useful comparison is with your own previous years and with businesses like yours.

Check it at least once a quarter rather than only at year end. A margin that has been slipping for two quarters can be corrected while it is still small.

For owner-run businesses, deduct a fair salary for yourself before calculating the margin. Without it, you cannot tell whether the business pays you more than a job would, or less.

When you compare an offer to buy or invest in a business, ask for the margin over several years. One strong year can be the result of a one-off gain or a delayed expense.

Mistakes that distort net profit margin

• Using profit before tax. Tax is a real cost to the owner, so use profit after tax when you want the net figure.
• Leaving out the owner's pay. If you work in your own business without a salary, the margin looks better than the business really is.
• Counting one-off gains. A profit from selling a vehicle is not repeatable and should be excluded when you compare operating performance.
• Including GST in revenue. Tax collected for the government inflates sales and makes the margin look lower.
• Mixing cash and accrual. A large bill paid in April but incurred in March belongs to March, so match costs to the period in which they were earned.
• Comparing across industries. A software firm and a trading business have entirely different cost structures, so compare with similar businesses.

If the net margin is thin, work back up the ladder. A weak gross margin needs a pricing or sourcing fix; a healthy gross margin with a weak net margin usually points to overheads. The gross profit margin guide covers the first half of the ladder.