Net Profit Ratio (NP Ratio):

Definition of net profit ratio:

Net profit ratio is the ratio of net profit (after taxes) to net sales. It is expressed as percentage.

Components of net profit ratio:

The two basic components of the net profit ratio are the net profit and sales. The net profits are obtained after deducting income-tax and, generally, non-operating expenses and incomes are excluded from the net profits for calculating this ratio. Thus, incomes such as interest on investments outside the business, profit on sales of fixed assets and losses on sales of fixed assets, etc are excluded.

Formula:

[Net Profit Ratio = (Net profit / Net sales) × 100]

Example:

Total sales = $520,000; Sales returns = $ 20,000;  Net profit $40,000

Calculate net profit ratio.

Calculation:

Net sales = (520,000 – 20,000) = 500,000

Net Profit Ratio = [(40,000 / 500,000) × 100]

= 8%

Significance:

NP ratio is used to measure the overall profitability and hence it is very useful to proprietors. The ratio is very useful as if the net profit is not sufficient, the firm shall not be able to achieve a satisfactory return on its investment.

This ratio also indicates the firm's capacity to face adverse economic conditions such as price competition, low demand, etc. Obviously, higher the ratio the better is the profitability. But while interpreting the ratio it should be kept in mind that the performance of profits also be seen in relation to investments or capital of the firm and not only in relation to sales.

 

You may also be interested in other relevant articles: Horizontal Analysis or Trend Analysis Trend Percentage Vertical Analysis Limitations of Financial Statement Analysis Accounting Ratios definition, advantages, classifications and limitations Financial Ratio Formulas Profitability ratios: Gross profit ratio Net profit ratio Operating ratio Expense ratio Return on shareholders investment or net worth Return on equity capital Return on capital employed (ROCE) ratio Dividend yield ratio Dividend payout ratio Earnings Per Share Ratio Price earning ratio Liquidity ratios: Current ratio Liquid /Acid test / Quick ratio Activity ratios: Inventory/Stock turnover ratio Debtors/Receivables turnover ratio Average collection period Creditors/Payable turnover ratio Working capital turnover ratio Fixed assets turnover ratio Over and under trading Leverage ratios or long term solvency ratios: Debt equity ratio Proprietary or Equity ratio Ratio of fixed assets to shareholders funds Ratio of current assets to shareholders funds Interest coverage or debt service ratio Capital gearing ratio Over and under capitalization

 

Our Request Dear visitor! Do you like this article? If you like, then please bookmark this page and also share with your friends. Thank you for your support.  [Report Errors and Omissions]

Back to Home Page | Back to Financial Statement Analysis Page