Many small business owners in South Africa, and across the world, are primarily concerned with calculating profit and loss that they often overlook the importance of net profit margin and the impact it has on the business, revenue, and profitability as whole.
Understanding why net profit margin is such an important metric hinges on the following:
- Defining net profit margin
- The net profit margin formula
- Measuring the impact of net profit margin on your business
Net profit margin defined
The net profit margin formula is as follows: (Net Profit Margin = Net Income / Sales).
The formula factors in a range of criteria including cost of goods, operating costs and more and shows the percentage of profit from your sales.
You typically multiply your net profit margin by 100 to understand the percentage of how much of your total sales revenue is profit.
Overall net profit margin is key to understanding the mechanics of a business and where and how processes can be streamlined.
Why net profit margin is important
The importance of why and how to calculate net profit margin is paramount to not just company health and profitability but the ability to forecast and understand areas of both growth and concern.
It is important to understand the impact:
- A high profit margin indicates that a company is healthy.
- A low profit margin can mean various things, it can show areas of concern as well as where expenses can be better managed.
As net profit margin is so important, ensuring that your accounting tools and software can track and report on this metric is critical for small business owners.
How to calculate net profit margin
The easiest way to visualize the net profit margin formula is through a simple example. The formula is: (Net Profit Margin = Net Income / Sales).
Assuming your business makes R50,000 in sales, your cost of goods are R15,000 and your operating costs are R5,000 your net profit margin calculation would look like:
Total sales – (cost of goods + operating costs)
R50,000 – (R15,000 + R5,000) = R30,000
Net profit margin:
Net income / sales
R30,000 / R50,000 = 0.6
Net profit margin percentage:
0.6 x 100 = 60%
In this case the net profit margin is 60%, and 60% of total revenue is profit. This showcases a very healthy company that has a good handle on cost of goods and operating expenses linked to product creation.
If you’re foregoing an accountant in order to maintain control over your own books, here are a few additional accounting formulas you should know.
Ensure your business is on track
Navigating the business landscape can be a challenge and ensuring you have the right tools in place is key to ensuring success. Accounting software that helps provide visibility into key metrics to improve business performance is a critical piece of the puzzle and is useful for businesses of any size, although particularly for small businesses just starting out.
Accounting software helps you save time, money, and resources, all of which are featured and are weighted in the criteria in assessing viability and form part of the net profit margin calculation. Try Quickbooks free for 30 days and begin streamlining your processes.