Net Income reflects how much money a business makes after all expenses are deducted from Net Sales. The problem with just looking at total Net Income dollars is the amount of Net Income being reported is greatly influenced by how much sales were generated.
A business may make less money from sales while reporting higher total Net Income dollars. Calculating the Net Income Margin Ratio gives you a more accurate picture of how efficiently your business has converted sales into profits.
Overview
Net Income Margin Ratio is a Profitability Ratio that measures how effectively a company can convert sales into Net Income. Also called the Net Profit Ratio or the Return on Sales Ratio. It validates a company’s pricing policies and its ability to control variable, fixed, and nonoperating costs. A low Net Income Margin indicates high risk, with the possibility that a decline in sales will erase profits and result in loss.
Indirectly, Net Income Margin Ratio measures how well a company manages its expenses relative to its Net Sales by showing what percentage of sales are left over after all expenses are paid. A business earns a higher Net Income Margin Ratio by generating more revenues while keeping expenses constant, or, by keeping revenues constant and lowering expenses.
The formula for Net Income Margin Ratio is as follows:
(Operating Income + Other Income – Other Expenses – ITDA) / Net Sales
A 10% Net Profit Margin Ratio means that for every dollar of sales, only 10 cents remains as profit to be paid out as dividends or reinvested into the business.
Higher is Better: company is running efficiently, creditors will get paid, and owners will get a return on their investment.
Lower is Worse: indicates expenses are too high; management needs to tighten its budget and reduce expenses.