Understanding Net Margin

Net Margin is the company's Net Profit divided by the Total Revenue. This profitability metric indicates how much of a net profit is generated for each rupee of revenue earned and expressed as a percentage. It measures the company's profitability and management's capability to manage its expenses to generate profit. Net Margin is also known as the Sales Ratio or Net Profit Margin. A high net margin indicates positive returns in the business, and the company is efficiently managing its expenses and converting its sales into a profit.

The formula to derive Net Margin



Net Profit - also known as Net Income or Bottom Line. It is a portion of the money that the company left after they subtracted their total business expenses from their total revenue. Net profit is found at the bottom of the Income Statement.

Total Revenue - It indicates how much a company's revenue is before deducting any expenses. Total revenue is found in the company's Income Statement.

Example of Net Margin: For the financial year, Eicher Motors reported a Net Profit as Rs.1346.89 Cr., and Total Revenue as Rs. 8661.56 Cr.
The Net Margin as per the formula (Net Margin = Net Profit/Total Revenue x 100) is calculated as (1346.89/8661.56 x 100) = 15.55%.

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Key Highlights

Net Margin is a profitability metric that indicates how much a net profit is generated for each rupee of revenue earned.

The higher net margin is considered good. It indicates the company's ability to convert its sales into a profit.

While doing analysis, always compare companies that operate in the same industry and also compare the data of current and previous years to understand the company's performance over the years.

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While looking at Net Margin, the following points should also take into consideration:

A higher net margin is considered good. It indicates the company is efficiently managing its expenses and generating profits from its sales. The high net margin of the company can be a result of the company's sales being in high demand or the total expenses being low.

A net margin of 15% or higher is considered good. The 15% means that the company generated fifteen percent net profit compared to its revenue.

This ratio can be used by an investor to compare the profitability across various accounting periods. This makes it easier to determine how well the financial metrics are performing. By monitoring their net margin ratios over time, this can also be helpful to project future net income based on revenue.

When a business applies for a loan, this ratio is extremely important. Before deciding to approve a loan, banks and lenders consider the company's net profit margin. Additionally, banks prefer companies with higher margins because they are more likely to have robust cash flows and a higher chance of repaying the loan.

A low net margin indicates that the company's sales are less, or total expenses are very high, and the company is not managing its expenses efficiently.

Low net margin but continuous growing year-over-year of the particular company is a plus point while analyzing that company. It indicates that the company is improving its management efficiency and increasing its sales or decreasing its expenses.

Some investors choose to stay away from companies that have low net margins. And some look for low net margin companies, but they should have high revenue compared to their peers because they think that competitors of that company will face a tough time stealing market shares from them.

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How to use Net Margin effectively

Companies with high net margins of 15% or higher are usually considered good. This metric indicates the company's ability to convert its sales into a profit.

While doing analysis, always compare companies that operate in the same industry and also compare the data of current and previous years to understand the company's performance over the years.

Net margin is only a part of the strategy while analyzing companies fundamentals. For better analysis, we should check other financial metrics like EBITDA Margin, Operating Margin, EPS, Cash EPS, etc.,

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Analysis of Different Scenarios in Net Margin

Sudden Fall: Can be due sudden gain in operating expenses.

Sudden Gain: Can be due to sudden fall in operating expenses.

Negative: Operating expenses are more than its revenue or total sales.

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