Understanding net margin

Definition

Net margin is net income divided by sales, shown as a percent. On the books, this is a ratio read from the Income Statement, not a ledger account you debit and not a cash balance.

A florist uses it to see how much of each sales dollar remains after product cost, running costs, interest, and tax. A 10 percent reading means ten cents of leftover on every dollar of sales.

It is not a Balance Sheet line. The statement computes it each period from this month's leftover and this month's sales.

Stay with the percent when you read it. The dollar leftover can rise while this percent falls, if sales grew faster than that leftover.

Where it shows up

P&L: Related to net income divided by revenue.

Cash flow: Related to whether profit is turning into cash, which this ratio does not show.

See also: Net Income · Revenue · Operating Margin

When you look at your Income Statement, this percent is not its own printed account. It is revenue and the bottom-line leftover, restated as a rate.

When the percent is high, the shop kept more of each sales dollar after every cost. When it is low, product cost, overhead, interest, or tax ate more of each dollar.

The Balance Sheet does not print this rate. The cash, inventory, and unpaid bills behind the month sit there instead.

Operating margin is leftover after product cost and the costs of staying open, as a percent of sales. This rate waits until interest and tax have come out as well.

Gross margin is leftover after product cost only. This rate is further down the statement, so it is usually a smaller percent.

On the Statement of Cash Flows, this percent does not appear as a line. Cash from operations is a different story from how much of each sales dollar the shop kept after every cost.

How it works

Take this period's net income. Divide it by this period's sales.

Write the result as a percent. $8,000 left from $80,000 of sales is 10 percent.

Use the same period for both numbers. Mixing last year's leftover with this year's sales will not tell you this month's rate.

Stay with this rate when you read it. A dollar leftover that grew because the florist opened a second cooler is not the same story as a rate that held steady.

Operating expenses sit inside the leftover used here. A rent increase with flat sales will pull this percent down.

Operating income is the leftover before interest and tax. Interest or a tax charge can pull this rate below the operating rate even when the shop's core work held.

Do not treat a single wedding weekend as the monthly rate. The percent uses the whole period's sales and the whole period's leftover.

After the month closes, this rate is part of the period's profit story. Next month starts the count again from zero.

A planned percent set next to the actual percent shows whether the shop kept the rate it meant to keep. The gap is a reading of this rate, not a new account.

Do not treat a high rate as proof the shop is flush with cash. Invoices can still sit open, and a high share of a slow week is still a small dollar leftover.

Example

Petal Lane posts $80,000 of bouquet and event sales this month. Net income is $8,000 after product cost, running costs, interest, and tax.

Divide $8,000 by $80,000. Net margin is 10 percent.

Last month the shop posted $70,000 of sales and $7,000 of leftover, also 10 percent. Dollar leftover rose this month, but the rate held.

If interest rose $800 and sales stayed $80,000, leftover would be $7,200. The rate would fall to 9 percent.

A wedding week that adds $10,000 of sales at the same leftover rate will raise dollars and leave the percent near 10. A week of heavy overtime in the workroom will lower the percent even if sales hold.

A second month at $88,000 of sales and $8,000 of leftover would be about 9 percent. Dollars held; the rate slipped because sales grew without more leftover.

Common mix-ups

Net margin is not the same as net income. Net income is the dollar leftover; this reading is that leftover as a percent of sales.

Net margin is not the same as operating margin. Operating margin stops before interest and taxes; this rate waits until those items have come out.

Net margin is not the same as cash. A month can show a healthy percent while the bank account is waiting on collections.

Related terms

• Net Income: What is left from revenue after every expense, including interest and taxes, is subtracted.
• Revenue: The total value of goods and services the business earned in a period.
• Operating Margin: Operating income as a percentage of revenue.
• Gross Margin: Gross profit expressed as a percentage of revenue.
• Income Statement: A statement showing revenue earned and expenses incurred over a period, ending in net income.
• EBITDA Margin: EBITDA as a percentage of revenue.
• Budget Versus Actual: The comparison of planned amounts to what actually happened.
• Return On Assets: Net income measured against total assets.