Net Profit Ratio, also referred to as the Net Profit Margin Ratio, is a profitability ratio that measures the company’s profits to the total amount of money brought into the business. In other words, the net profit margin ratio depicts the relationship between the net profit after taxes and net sales taking place in a business.
It is a profitability ratio and hence, expressed in the form of percentages. Net profit ratio is regarded as a good measure of the firm’s overall performance and it becomes more effective when it is used in conjunction with the evaluation of the working capital of the firm.
It helps in determining the overall efficiency of the business and net profit ratio is not considered as a reliable indicator of cash flows as it comprises many expenses such as non-cash expenses, accrued expenses, depreciation and amortization.
The formula for calculating net profit ratio is
Net Profit Ratio = (Net Profit / Net Sales) × 100
Where, Net Profit = Gross Profit + Indirect Income – Indirect Expenses
Net Sales = Sales – Returns
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Solved Example
Calculate Net Profit Ratio from the below information.
| Sales | 8,00,000 |
| Sales Returns | 3,00,000 |
| Direct Costs | 1,00,000 |
| Indirect Costs | 2,50,000 |
Answer
We know,
Net Profit Ratio = (Net Profit / Net Sales) × 100
Here, Net sales = Sales – returns
Net Profit = Gross Profit + Indirect Income – Indirect Expenses
Therefore,
Net Sales = 8,00,000 – 3,00,000
= 5,00,000
Net Profit = Operating profit – (Direct Cost + Indirect Cost)
= 5,00,000 – ( 1,00,000 + 2,50,000)
= 5,00,000 – 3,50,000
= 1,50,000
Now Net Profit Ratio = 1,50,000/ 5,00,000 × 100
= 0.3 or 30%
This means that the company has a net profit margin of 30%.
Drawbacks of Net Profit Ratio
Net profit ratio is a short-term measure of determining the profit and in the long term as it does not reveal the company’s strategy to maintain profitability during that period.
This concludes our article on the topic of Net Profit Ratio, which is an important topic in Accountancy for Commerce students. For more such interesting articles, stay tuned to BYJU’S.
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