What is Net Margin?
Net margin is the percentage of revenue remaining after all operating expenses, interest, taxes and preferred stock dividends (but not common stock dividends) have been deducted from a company's total revenue.
How Does Net Margin Work?
The formula to calculate net margin is:
(Total Revenue – Total Expenses)/Total Revenue = Net Profit/Total Revenue = Net Margin
Let's look at a hypothetical income statement for Company XYZ:
Using the formula and the information above, we can calculate that Company XYZ's net margin was $30,000/$100,000 = 30%
Why Does Net Margin Matter?
Net margin is one of the most closely followed numbers in finance. Shareholders look at net margin closely because it shows how good a company is at converting revenue into profits available for shareholders.
One of the most important concepts to understand is that net profit is not a measure of how much cash a company earned during a given period. This is because the income statement includes a lot of non-cash expenses such as depreciation and amortization. To learn about how much cash a company generates, you need to examine the cash flow statement.
Changes in net margin are endlessly scrutinized. In general, when a company's net margin is declining over time, a myriad of problems could be to blame, ranging from decreasing sales to poor customer experience to inadequate expense management.
Net margin is often used to compare companies within the same industry, in a process known as "margin analysis." Net margin is a percentage of sales, not an absolute number, so it can be extremely useful to compare net margins among a group of companies to see which are most effective at converting sales into profits.
If you'd like to read more in-depth information about margin analysis, check out the following:
Operating Margin definition -- learn how gross profit margin is related to net profit margin.