Net profit ratio (NP ratio)
expresses the relationship between net profit after taxes and sales. This ratio
is a measure of the overall profitability net profit is arrived at after taking
into account both the operating and non-operating items of incomes and expenses.
The ratio indicates what portion of the net sales is left for the owners after
all expenses have been met.Formula:
Following formula is used to calculate net
profit ratio:
Net profit ratio = (Net profit
after tax / Net sales) ×
100
It is expressed in percentage. Higher the net
profit ratio, higher is the profitability of the business.
Example:
From the following information calculate net
profit ratio (NP ratio)
Total sales = $520,000; Sales
returns = $ 20,000; Net profit $40,000
Net sales = (520,000 –
20,000) = 500,000
Net Profit Ratio =
[(40,000 / 500,000) × 100]
= 8%
Significance:
Net profit 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. |
