Net profit (NP) ratio

By: Rashid Javed | Updated on: October 24th, 2021

Net profit ratio (NP ratio) is a popular profitability ratio that shows the relationship between net profit after tax and net sales revenue of a business entity. It shows the amount of profit earned by an entity for each dollar of sales and is computed by dividing the net profit after tax by the net sales for the period concerned. Both the numbers needed to calculate this ratio can be taken from entity’s income statement or profit and loss account. Net profit ratio is also frequently referred to as profit margin on sales.

Formula:

net-profit-ratio-img1

For the purpose of this ratio, net profit is the net income or net profit of the entity as exhibited by its income statement or profit and loss account. Unlike operating profit ratio which considers only operating profit, the numerator in net profit ratio is the profit number arrived at by considering all operating as well as non-operating revenues and expenses. The denominator used is, however, the net sales which is typically the entity’s primary source of revenue.

The relationship between net profit and net sales may also be expressed in percentage form. When it is shown in percentage form, it is known as net profit margin. The formula of net profit margin can be written as follows:

net-profit-ratio-img2

Examples

Example 1

The following data has been extracted from income statement of Zain & Maria corporation.

  • Gross sales: $210,000
  • Returns inwards: $10,000
  • Net profit before tax: $50,000
  • Income tax: 10%

Required: Compute net profit ratio of Zain & Maria corporation using above information.

Solution:

= ($45,000* / $200,000**)
= 0.225
or
=22.5%

*Net profit after tax:
= $50,000 – ($50,000 × 0.1)
=$50,000 – $5,000
= $45,000

** Net sales:
= $210,000 – $10,000
= $200,000

Example 2

Hafza Company’s income statement for the year ended December 31, 2021 is presented below:

Required: Determine the net profit ratio of Hafza Company using the data from above income statement.

Solution

$304,000/$2,025,000
= 0.1501
or
= 15.01%

A D V E R T I S E M E N T

Significance and Interpretation:

Net profit (NP) ratio can be a useful tool for measuring the overall profitability and operating performance of a commercial entity. A high ratio number indicates an efficient management of operational affairs of the entity and a low number might indicate otherwise.

There is no norm to interpret this ratio. To see whether a business is constantly improving its profitability or not, the analyst should compare the ratio with the previous years’ ratio, the industry’s average and the budgeted net profit ratio.

The use of net profit ratio in conjunction with assets turnover ratio helps in ascertaining how profitably the management has managed and used the entity’s assets during the period concerned.

Net profit ratio should be applied in your analysis with caution because a low ratio may not always be a sign of bad operational performance. Entities would normally exhibit a low NP ratio when they adopt an affordable low-price strategy with the purpose to grasp a larger market share. Such entities can improve their NP ratio only by some possible reduction in costs, because raising the price of their products or services would result in lost market share.

Another problem with the net profit ratio is that it is not a long-term measurement of profitability. It is mostly calculated by using the numbers from a short-period (typically one year or less) operating result of the entity and therefore does not indicate anything about it’s ability to maintain operational performance on continuous basis. Moreover, an entity can temporarily improve its net profit ratio by delaying such expenditures which don’t have a significant immediate impact on profitability. For example, the management can intentionally postpone a periodic maintenance or similar other discretionary expenses etc. to gain a higher profit number and make the ratio temporarily look better.

A D V E R T I S E M E N T
33 Comments on Net profit (NP) ratio
  1. Arup Goswami

    Is net profit ratio calculated on net profit (after tax)/net sales*100. Please comment.

    1. R HARSHA RAJAN

      NET PROFIT RATIO=NET PROFIT AFTER TAX/REVENUE FROM OPERATIONS (NET SALES)* 100

  2. Accounting For Management

    Arup did you read the whole article? It explains in detail.
    Your formula is correct.

  3. Rahul Roy

    If the net profit margin is lower than previous year, what should be the suggestion to the company?

  4. umadevi

    if the net profit ratio is lower than previous year,what should be the suggestion to the company?

    1. sylvia

      general decline i guess , since an increase is generally looked at as positive growth

  5. Emerson

    What should be the action if the NP ration is lower than the previous year?

  6. Gourav

    how to calculate gross profit and net profit in the case of banks?

  7. Gourav

    How to calculate sales in the case of banks?

    1. Accounting For Management

      Banking companies have a different format of their profit and loss account /income statement. Banks do not make sales, their revenues include interest on loans, discount on bills and commission etc.

  8. pauline

    Net profit margin=profit for the year(less preference share dividend) /sales

  9. Deep

    Why closing stock is deducted from net sales. Is it applied to all kind of business sectors?

  10. kp

    if the net profit ratio is lower than the previous year, the company is in recession period of business cycle. So, it should revise the marketing plan for company.

  11. damilola

    what if there was a net loss instead of a profit, how do you calculate for that?

  12. DIVYA

    If net profit is less than the previous year what will be the suggestion given to the company.

  13. raghuveer

    is interest on debentures to be deducted on gross profit?

    is income tax is paid or provision?

  14. Meraj

    I want to use your website for studying purpose.

  15. kamlesh arya

    sir i have a question related to the ratio analysis..

    the following info is given on a question

    gross sale 5000000rs

    sale tax 8%

    profit before tax 1000000

    income tax rate 40%

    we have to find out net profit ratio as before tax

    ans is 21.74%

    please give me reply with full solution

    1. Accounting For Management

      Sales – sales tax
      $5000,000 – $400,000(8% of gross sales)
      =$4,600,000

      Np ratio = ($1000,000/$4,600,000)*100
      =21.74%

  16. sangeetha

    crushing tonnes expenses how to find percentage expenses

  17. sangeetha

    how to calculate total expenses percentage how to find it

  18. cookie

    how do you interpret net profit ratios when calculated?

  19. Sher

    What does a net loss percentage ratio means? Eg. if total net loss is 2,613,360 and total sales is 8,033,786. How would you interpret the results and what could be the possible cause? Thanks in advance for your assistance.

  20. Ajay

    Banks have different format of b/s & p&l a/c…
    how to calculate the 1)Gross Profit Ratio 2) Net Profit Ratio and 3)Fixed assets turnover ratio ?

  21. Nazim

    Dear accountant,
    Can you explain more about if I owned 5 star homes regarding to the net profit ratio?

  22. Nava Thakuria

    how to calculte net profit ratii if there is loss in the company?

  23. slondy

    how to interpret net profit ratio? what would you say is a reason for one company having net profit greater than the other

  24. Anjana M S

    How to calculate net profit ratio of banks?? Please explain

  25. Rizwan shiekh

    Hii, i have a que. Plz solve this.
    The que. Is
    For the year ended on 31st march 2013
    Cost of good sold = 60,000 . GP ratio 25% on sales. Net profit ratio =10% on sales.
    Intrest received =1200. Intrest paid =700.
    Calculate the net profit earned during the year.

  26. Mehar Krishna

    When net profit = profit after tax / net sales*100

    Now the company was came netloss
    How to it will be calculate ???

  27. Ayushi

    My net profit ratio is coming 8.85percent…..?? So what is its interpretation and analysis??

  28. KERS

    Why are we dividing net income to sales????? answer asap

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