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Net profit margin

A net profit margin reflects the amount of money that a company has made, after tax, expressed as a percentage of its overall revenue.

Let’s imagine that a balloon company generated $3 million in revenue – the total amount it received over the year. If $300,000 was left in profit after taxes and expenses were taken care of, this would mean its net profit margin is 10%. As an alternative, this can also be expressed in decimal form as 0.10.

Net profit margin explained

This measurement is especially useful for investors because it gives them an at-a-glance view of how much profit a company makes for every dollar in revenue they generate. For example, in the balloon example, every $1 collected delivers $0.10 in profit.

It also makes it a lot easier to compare businesses that might be of vastly different sizes – and even in completely different industries. Instead of looking at the total net profit that a company is making – which could be $10,000 in one case and $2.5 million in another – it focuses on the ratio of profits to expenses. A multimillion-dollar firm might have blockbuster revenues of $25 million, but its $150,000 net profit would pale into comparison to a business with $2 million revenue and net profits of $500,000.

Investors can also use net profit margins to see whether or not a company is making progress. If a company’s margin was 17% one year and 12% the next, this might prompt them to look for alternative opportunities. On the flipside, continued growth in a margin would deliver confidence that the business is in good financial health and on the right path.

However, when all of this is said and done, net profit margins cannot be relied on exclusively. This is a warts-and-all measurement that takes into account one-offs – whether this is a sudden expense that won’t reoccur in subsequent reporting periods, or an unexpected windfall that temporarily boosts the bottom line. As a result of this, it’s prudent to look at other metrics when trying to assess a firm’s financial standing.

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