What is a Net Margin?

Sometimes referred to as a net profit margin, the net margin is the amount of profits that are left after the company has settled all expenses, costs of production, and applicable taxes. The costs of production include such items as wages and salaries, rental of equipment and facilities, utilities, and any other element that is essential to the production and delivery of goods and services to a customer. Properly calculating the net margin is considered important to evaluating the current position of the business, both in terms of true profitability and efficiency.

Some businesses rely on very simplistic methods to determine the net margin. A basic approach is to simply deduct all related expenditures from the amount of revenue that is taken in during the period under consideration. Others prefer to make use of formulas that provide a percentage rather than an exact figure. Both approaches can work very well, and yield valuable information about how well the business is performing, provided that the method used to calculate net margins is consistent from one period to the next.

Comparing the net margin from one fiscal period to the next can often help companies identify trends that could negatively impact the business before they become major issues. When there is a slight but significant change in the margin from one period to the next, the origin of the change can be investigated. If it is determined that the downturn in profit margin was due to a transient factor, such as a holiday or an anticipated seasonal downturn, there is usually no cause for alarm. Should the origin of the decrease be something that could prove to be an ongoing factor, such as a change in consumer tastes, the early detection allows the company to adjust production schedules and take other appropriate steps to turn the situation to its benefit.

In some cases, careful calculation of the net margin can make it possible to identify areas of the operation that could be improved. For example, careful scrutiny may reveal that a change in procedures in one or more departments will help employees process more units within the same amount of time, thus increasing output and the ability to fill outstanding orders. Companies have noted a change in profit margins and implemented investigations that led to combining departments, replacing worn machinery that was hampering the production effort, or other forms of reorganization that resulted in an increase in profits without creation an appreciable increase in expenditures.