Net profit margin measures how much of each pound (or dollar) of revenue a company retains as profit after all expenses. It is one of the most important indicators of a business's financial health.
The Formula
Net profit margin = (Net profit ÷ Revenue) × 100
Where net profit = Revenue − All expenses (COGS, operating costs, interest, tax)
Example:
- Revenue: £500,000
- Net profit: £45,000
Net profit margin = (45,000 ÷ 500,000) × 100 = 9%
Profit Margin Hierarchy
There are three key margin metrics, each stripping out more costs:
| Metric | Formula | What it excludes |
|---|---|---|
| Gross margin | (Revenue − COGS) ÷ Revenue | Only cost of goods |
| Operating margin | Operating profit ÷ Revenue | COGS + operating expenses |
| Net margin | Net profit ÷ Revenue | All expenses incl. tax & interest |
What Is a Good Net Margin?
Margins vary enormously by industry:
| Industry | Typical net margin |
|---|---|
| Software / SaaS | 15–30% |
| Financial services | 15–25% |
| Retail (grocery) | 1–3% |
| Retail (luxury) | 8–15% |
| Manufacturing | 5–10% |
| Restaurants | 3–9% |
| Construction | 2–6% |
Compare within your industry, not across sectors.
Worked Example: Income Statement
| Item | Amount |
|---|---|
| Revenue | £800,000 |
| Cost of goods sold | −£320,000 |
| Gross profit | £480,000 |
| Operating expenses | −£250,000 |
| Operating profit (EBIT) | £230,000 |
| Interest expense | −£15,000 |
| Profit before tax | £215,000 |
| Tax (20%) | −£43,000 |
| Net profit | £172,000 |
| Net margin | 21.5% |
Why Margins Matter
- A rising margin signals improving efficiency or pricing power
- A falling margin despite growing revenue is a warning sign
- Lenders and investors use margins to assess financial stability
- Compare to prior years and industry peers for meaningful analysis
Improving Net Margin
- Increase prices (requires pricing power or strong brand)
- Reduce COGS through supplier negotiation or process improvement
- Cut operating costs — but not at the expense of growth
- Optimise tax position through legitimate planning
- Improve working capital to reduce financing costs
Net Margin vs Gross Margin
If your gross margin is healthy but net margin is thin, the problem is in operating costs. If both are thin, your pricing or production cost model needs attention.