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The net profit margin is the proportion of sales revenue that is left once all costs have been paid. It tells a business how much net profit is made for every pound of sales revenue received. For example, a net profit margin of 32% means that every pound of sales provides 32 pence of net profit.

In the same way that net profit is lower than gross profit, because it accounts for more costs, the net profit margin will be lower than the gross profit margin. In markets that are particularly competitive, such as the food retail market, net profit margins can be very small.

Calculating the net profit margin

In order to calculate the net profit margin, a business will use the following formula:

For example, a business that knows its net profit and sales revenue can calculate its net profit margin as follows:

This shows that the net profit margin for this business decreased from 20% to 10% over the past two years.

Using the net profit margin

Businesses can use the net profit margin to identify what is happening to their fixed costs. They can do this in two ways:

• Comparing the net profit margin with the gross profit margin - By comparing the net profit margin with the gross profit margin for the same time period, a business can identify how significant its fixed costs, or overheads, are. For example, a business that has a gross profit margin of 50% and a net profit margin of 10% knows that for every pound of goods sold, 40 pence is used to pay fixed costs. This can then be used to identify whether there is any scope to reduce these fixed costs.
• Comparing net profit margins over time - By comparing net profit margins over time, a business can identify what is happening to its costs. For example, a decrease in net profit margin indicates either that sales revenue has fallen faster than costs or that costs have increased faster than sales revenue.