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Net margin is one of the most important indicators when evaluating the profitability of a business. But what exactly is it and how is it calculated? In this practical guide, we will explain to you in a simple way what net margin is, why it is relevant and how you can calculate it step by step to know the true profitability of your business.
What is Net Margin?
Net margin is a financial percentage that measures the profitability of a company. It indicates how much money from each sol [Peruvian currency] sold is converted into profit after subtracting all expenses, including production costs, marketing, distribution, taxes and other disbursements.
It is calculated by dividing the net profit by the total revenue and expressing it as a percentage. This allows analysts and entrepreneurs to assess how efficient the business is at generating real profits.
What is the net margin formula?
The net margin formula is as follows: Net Margin (%) = (Net Profit / Total Revenue) x 100
Where:
- Net Profit: It is the final balance of the income statement, obtained after deducting all expenses.
- Total Revenue: These are the total sales of the company without considering VAT.
Why is net margin important?
Net margin is key because it shows a company's ability to transform its revenue into profit. Unlike gross margin, which only takes into account the cost of production, net margin considers all additional costs, such as advertising, salaries, rents, debts and taxes.
In this way, the net margin is a more realistic indicator of the financial health of the business. If the net margin is low or negative, it means that the company is struggling to generate profits despite sales. Conversely, a high net margin indicates good cost management and increased profitability.
How to calculate net margin? Step by step
Calculating the net margin is simpler than it seems. Follow these steps carefully so that you don't make any mistakes:
Step 1: Identify total revenue
Determine how much money has come into your business from sales in a given period. For example, let's suppose that your company has sold 50,000 soles in a month.
Step 2: Add up all business expenses
It includes all the costs that you have had to operate your business, such as salaries, rent, taxes, marketing and production costs. If we follow this example, imagine that the total expenses of your business amount to 35,000 soles. You already have this key data.
Step 3: Calculate the net profit
Subtract total expenses from total revenues:
- Net Profit = Total Revenue – Total Expenses
- Net Profit = 50,000 – 35,000 = 15,000
Step 4: Apply the formula
Divide the net profit by the total revenue and multiply the result by 100 to get the percentage:
Net Margin (%) = (15,000 / 50,000) x 100 = 30%
This means that for every sol that you take in, you earn 30 cents after deducting all expenses.
What can you do with the net margin?
After knowing your net margin, you can make strategic decisions to improve the profitability of your business. Some actions include:
Reduce unnecessary costs: Analyze your expenses and eliminate those that are not indispensable.
- Optimize pricing: Make sure the sales price covers all costs and leaves an adequate profit margin.
- Improve operational efficiency: Look for ways to optimize production and reduce waste.
- Negotiate with suppliers/providers: Getting better prices on supplies and services can improve your net margin.
More on the Finance for Entrepreneurs program
There is no doubt that net margin is a key indicator for any entrepreneur or analyst, as it reflects the true profitability of a business. For more tips, follow closely the program “Finance for Entrepreneurs” program of the Wiese Foundation, which is a guide that you can use to improve your fundamental knowledge in the financial realm.
