# Net Profit Ratio

Last Updated : 02 May, 2023

### What is Net Profit Ratio?

Net Profit Ratio shows the relationship between the net profit and net revenue from operations based on the all-inclusive concept of profit. It links operating revenue to net profit after operational and non-operational costs and incomes. Profitability is the primary goal of any firm. Profitability Ratios are determined to examine a company’s earning potential, which is the result of how well its resources are used. Net profit refers to the profit after tax (EAT).

Generally, a company with a high net profit ratio can successfully manage its costs and/or offer products or services for a price that is much higher than its costs. Consequently, a high ratio may be generated by:

• Optimal management
• Low prices (expenses)
• Effective pricing tactics

Whereas, a company that has a low net profit ratio either has an inefficient cost structure or uses bad pricing tactics. Consequently, a low ratio may be formed by:

• High prices (expenses)
• Poor pricing tactics

Investors should utilise the profit margin ratio’s figures as a general measure of a company’s profitability performance and, as necessary, initiate in-depth investigations of the factors that contribute to an increase or decrease in profitability.

### Formula of Net Profit Ratio

Net Profit Ratio =

Where,

Net Profit = Gross Profit – Indirect Expenses & Losses + Other Incomes – Tax

Indirect Expenses and Losses = Office Expenses + Selling Expenses + Interest on Long term borrowings + Accidental Losses

### Explanation of Formula of Net Profit Ratio

In the formula, Net profit is calculated after deducting total expenses from total revenues. The Profit calculated from the Trading and Profit & Loss Account, i.e. Gross Profit, is taken. From the Gross Profit, indirect expenses are deducted, and other incomes are added to reach the Net Profit in Profit & Loss Account. The net profit percentage is calculated by dividing after-tax profits by net sales. It displays the residual profit after the recognition of income taxes and the deduction of all manufacturing, administrative, and financing costs from sales.

• Net Profit: The money company makes after deducting all operational, interest, and tax costs during a specific period is known as net profit. The bottom line of the financial statement is reflected by the net profit in the balance sheet.
• Revenue from Operations: The income a company generates from its regular, core business operations is known as revenue from operations, or operating revenue. It is considered to have been running effectively if the entity can provide a consistent stream of income from its operations.

### Significance of Net Profit Ratio

The Net Profit Ratio measures the overall status of a firm, i.e. the amount of Net Profit generated by the company per revenue gained. After compensating all other stakeholders, including the government, the obligations of the shareholders of a company are resolved. Companies with larger net profit margins are more efficient in cost management and profit generation. It is expressed in the form of percentages because it is a profitability ratio.

### Examples of Net Profit Ratio

#### Illustration 1:

Calculate the Net Profit Ratio from the following:

#### Solution:

To calculate Net profit, all expenses are deducted from Gross profit.

Gross Profit= Revenue from Operations – Cost of Revenue from Operations

= Revenue from Operations – (Opening inventory + Purchases + Wages + Carriage Inwards – Closing Inventory)

= 25,00,000 – ( 4,00,000 + 12,00,000 + 2,70,000 + 1,40,000 – 3,10,000)

= 25,00,000 –  17,00,000

= â‚¹8,00,000

Net Profit = Gross Profit – Administrative Expenses – Selling Expenses – Income Tax + Profit on sale of fixed assets

= 8,00,000 – 75,000 – 25,000 -50,000 + 25,000

= â‚¹6,75,000

Net Profit Ratio =

= 27%

#### Illustration 2:

From the following calculate the Net Profit Ratio:

#### Solution:

Indirect Expenses and losses = Office Expenses + Interest on Debentures + Selling Expenses + Accidental losses

= 10,000 + 10,000 + 25,000 + 15,000

= â‚¹60,000

Other Income = Income from Rent + Commission Received

= 3,500 + 2,500

= â‚¹6,000

Net Profit = Gross Profit – Indirect Expenses & losses + Other Incomes

Net Profit = 84,000 – 60,000 + 6,000

Net Profit = â‚¹30,000

Revenue from Operations = â‚¹3,00,000

Net Profit Ratio =

= 10%

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