The net profit margin, also referred to as the Net Margin, is a profitability metric used in corporate finance that’s considered as the most comprehensive evaluative ratio. It reflects a business’s ability to turn its revenue into profit after accounting for all their day-to-day expenses, including taxes and debts. In order to compute a business’s Net Profit Margin their Net Profit has to be divided by their Net Sales, or their Net Income has to be divided by their revenue realized over a period of time.
A business with a Net Profit Margin that exceeds the industry’s average is said to have competitive advantage or is more successful compared to other companies with similar operations.
To increase a business’s Net Profit Margin, business owners can either increase sales or reduce expenses.
Boosting a Business’s Revenues
One way a business can improve their Net Profit Margin is by boosting revenues.
A business can increase their sales income by selling more of their goods or raising their prices. However, this strategy may discourage customers with price inflation and affect their revenues in the end. Also, if their product’s demand isn’t high enough, a surge in production at the wrong time can leave inventory depreciating and incur additional expenses for the business.
When using this strategy of boosting revenues, business owners should take into account how much the market can bear when it comes to purchasing their products and adding to the price of their products.
Taking the Net Profit Margin formula into consideration, boosting revenues is a double-edged sword. Because Net Profit Margin is computed by dividing Net Profit by Total Sales, the bottom figure will increase. The benefit of additional sales is just offset when using this metric. A better strategy will be to increase sales and to decrease expenses simultaneously.
Reducing a Business’s Operating Costs
Almost all companies incur their greatest expenses from the everyday operations of their businesses, including their production of goods for sale. This is why one strategy in order to increase Net Profit Margin is for businesses to reduce their operating expenses.
Reducing operating expenses may be done by relocating the business’s workspace to a cheaper location, paying for a smaller production space, or even reducing their workforce. However, these changes will surely affect a business’s intangible assets, like perception and goodwill.
Another way to control a business’s costs is to find cheaper suppliers for raw materials needed to produce goods, without sacrificing the quality of their products. When a business produces low quality goods to cut expenses, they will likely lose many customers to competitors.
Therefore, to reduce production costs while maintaining the quality of their goods, the best option for most businesses is expansion. When a business increases production level, the cost of each item is reduced in several ways. For example, raw materials purchased in bulk are usually discounted by suppliers. A higher production level also means that some operating costs are more spread out, such as costs for advertising, research, development, depreciation, and administration.
Funding a company’s expansion may be an effective long-term strategy to improve Net Profit Margin because it increases a business’s production level, drives higher sales volume, and reduces the average cost for each good produced.
Net Profit Margin is a business’s profitability measure, computed by dividing the Net Profit by Total Sales. When the Net Profit Margin exceeds an industry’s average, it means the business has competitive advantage.
Most companies improve their Net Profit Margins by increasing revenues or reducing costs. However, a better strategy is for a business to do these simultaneously.