Net Income vs Net Profit Margin Differences and Similarities
Financial analysis is an important tool that is used by investors or managers to evaluate the financial health of a business, in order to make investment or management decisions. One of the factors that are put into consideration when carrying out a financial analysis of a business is its profitability. Hence, when it comes to the profitability of a business, comparing either the company’s net income vs net profit margin to that of other companies is crucial. That is, the net income and net profit margin as financial metrics, provide a basis for financial management or decision-making because they give an insight into the financial health of a company.
A company’s net income is not the same thing as its net profit margin, though they are related. The net income represents the profit made after all expenses have been subtracted from a company’s total revenue while the net profit margin is a type of profitability ratio, that shows the total number of cents per dollar that is gained on a sale that a company keeps as profit. In this article, we will compare net income vs net profit margin differences and similarities. But, first, what do we understand by a company’s net income or net profit margin?
Related: Liabilities vs Assets Differences and Similarities
What is net income?
Since profit and earnings are synonymously used for income (depending on UK and US usage), net earnings and net profit are commonly used interchangeably for net income. Hence, net income is also referred to as net profit, total comprehensive income, net earnings, bottom line, or sales profit. It is considered the ‘bottom line’ figure on the income statement because it is the residual of all revenues and gains minus all expenses and losses for the accounting period. That is, it is usually found on the last line of a company’s income statement while revenue is usually the first line figure on the income statement and as such is termed the ‘top-line’ figure.
The revenue and expense figures that are used to calculate the net income can be obtained from the business’s income statement. It is usually calculated to show the net profit for a specific accounting period which could be the net profit for a month, a quarter, six months, or one year. Moreso, it is important to note that net income is different from gross income. Gross income is the figure derived from deducting the cost of goods sold (also known as cost of sale) from revenue while net income is the figure derived from deducting all expenses from revenue.
Therefore, for households and individuals, net income is referred to as gross income minus taxes and other deductions (e.g. mandatory pension contributions). For a merchandising company, costs such as the cost of goods sold, sales discounts, as well as sales returns and allowances are subtracted from the total revenue to get the net income. Whereas, for a product company, costs like advertising, manufacturing, design, and development costs are included in the subtracted cost. Hence, a company’s net income can be calculated by adding its operating income to its non-operating income and then subtracting all expenses and taxes.
Furthermore, net income is defined as the net increase in shareholders’ equity that results from a company’s operations. A company’s net income can be distributed as a dividend among holders of common stock or can be held by the company as an addition to retained earnings.
In conclusion, net income (or net profit) is the money that is left over after paying all the expenses of a company or business. Hence, it can be used to calculate earnings per share for investors and some profitability ratios like the Net profit margin, Return on assets (ROA), Return on invested capital (ROIC), and Return on equity (ROE). Since net income is used to calculate net profit margin, it means there is a relationship between the net income vs net profit margin.
See also: Income Statement Ratios Formulas and Examples
What is net profit margin?
The net profit margin is one of the profit margins that is usually calculated to evaluate the financial health of a company. There are other types of profit margins such as gross profit margin, operating profit margin, and pre-tax profit margin. However, the net profit margin is the most commonly used margin among them. A net profit margin compares a company’s net profit which is the figure that is left over after any taxes and expenses have been deducted from the company’s revenue to its revenue. Hence, as a profitability ratio, the net profit margin includes all factors in a company’s operations, such as:
- Total revenue
- Additional streams of income
- Cost of goods sold (COGS)
- Operational expenses
- Interest expense on debt obligations
- Investment income and income from secondary operations
- Taxes and one-time payments for unusual events like lawsuits
The net margin compares the company’s profits to the total amount of money that it brings in and measures how effectively the company operates. That is, if a company has a 50% net profit margin, for instance, it means that the company makes $0.50 as profit for every $1 in sales revenue. Therefore, management can track the increases and decreases in its company’s net profit margin to assess whether current practices are working for the company and forecast profits based on revenues.
Also, by calculating a company’s net profit margin, investors compare the profitability of two or more businesses regardless of size and assess if the management of the company is generating enough profit from its sales. If a company has a growing revenue, but its operating costs are increasing at a faster rate than revenue, its net profit margin will reduce.
Generally, investors ideally want to see a track record of expanding margins, which indicates that the company’s net profit margin is rising over time. Hence, companies that tend to expand their net margins over time are rewarded with share price growth, because share price growth is usually highly correlated with earnings growth.
In conclusion, the net margin gives analysts a picture of a company’s financial stability. It is interpreted that companies that generate greater profit per dollar of sales are more efficient and are more likely to survive when a period of economic contraction hits the broader economy or when a product line doesn’t meet expectations.
Related: Net Income vs Net Revenue Differences and Similarities
Net income vs net profit margin differences
- The major difference between net income vs net profit margin is that a company’s net income is its total revenue minus its total expenses for an accounting period while the net profit margin is a ratio that shows how much net income (or net profit) the company generates as a percentage of its revenue.
- Another net income vs net profit margin difference is that net income is calculated by subtracting all expenses from the total revenue while the net profit margin is calculated by dividing net income by revenue.
- The difference in the net income vs net profit margin formula is; Net Income = Total Revenue – Total Expenses, while Net profit margin = Net income / Revenue.
- The net income shows the total cash inflow of revenue for a specific accounting period after all expenses have been deducted while the net margin shows the percentage of a company’s profits to its revenue.
- The net income is reported as a line figure on the income statement while the net profit margin is not reported on the income statement but can be calculated using the revenue and net income figures on the income statement.
Net income vs net profit margin formula
There is a difference between the formula for net income vs net profit margin.
Net income formula
In order to calculate the net income for a business, subtract all costs from the business’s total revenues or turnover. Hence, the net income formula is expressed as:
Net Income = Total Revenue – Total Expenses
OR
Net Income = Revenue − COGS − Operating Expenses − Other expenses − Interest − Taxes
Net profit margin formula
In order to calculate a business’s net profit margin, divide the company’s net profit or net income by its net sales or total revenue generated over a given accounting period and then multiply it by 100. Therefore, the formula for net profit margin is expressed as:
Net profit margin = {Net income (or net profit) / Revenue} x 100
OR
Net profit margin (NPM) = {(R − COGS − OE − O − I − T)/ R} x 100
Where,
- R = Revenue
- COGS = Cost of goods sold
- OE = Operating expenses
- O = Other expenses
- I = Interest
- T = Taxes
Net income vs net profit margin calculation
The resulting figure after calculating a company’s net income or net profit margin tells us about the profitability of a company. Let’s look at how the calculation for net income vs net profit margin is done. If for example, Jotscroll company recorded total revenue of $30,000 for the fiscal year, 2020 and also recorded total expenses that added up to $20,000 for that year with the following expense breakdown:
- COGS- $6,000
- Operating expenses- $5,000
- Other expenses- $3,500
- Interest- $2,500
- Taxes: -$3,000
Here is the difference in the company’s net income vs net profit margin calculation:
Net income calculation
In order to calculate the net income of Jotscroll company, we start with the company’s total revenue. From this figure, we will subtract the company’s expenses and all operating costs, and then deduct tax from this amount to get the net income. Hence, using the net income formula,
Net Income = Revenue – COGS – Operating Expenses – Other expenses – Interest -Taxes
Net income = $30,000 – $6,000 – $5,000 – $3,500 – $2,500 -$3,000
= $10,000
This means that Jotscroll company made a net income of $10,000 for the year 2020.
Net profit margin calculation
In order to calculate the net profit margin for Jotscroll company, we start by subtracting the cost of goods sold (COGS), operating expenses, other expenses, interest (on debt), and taxes payable from the company’s total revenue to get the company’s net income (or profit). Then, divide the net income by the total revenue. Also, we multiply the resulting figure by 100 in order to convert it to a percentage.
Recall, that we already calculated a net income of $10,000 for Jotscroll company. Hence, we will just plug the net income figure into the net profit margin formula. Therefore, using the net profit margin formula,
Net Profit Margin = {Net income / Revenue} x 100
Net profit margin = {$10,000 / $30,000} x 100
= {$10,000 / $30,000} x 100
= 0.33 x 100 = 33%
This means that Jotscroll company had a net profit margin of 33% for the FY, 2020. This means that Jotscroll company made $0.33 as profit for every dollar generated by the company in sales. In addition, when calculating a company’s net profit margin, you may not need to go through the process of subtracting the company’s expenses from revenue as we did above, because the company’s net income is always stated on its income statement.
Interpretation of Net income and Net profit margin
What does a company’s net income tell us compared to its net profit margin? A company’s net income can give us an overall idea of the company’s health because it shows profits after all expenses and taxes are deducted. Hence, if there is a major difference between a company’s gross and net income, it could be a warning sign. It could mean that either the company’s expenses are too high, its income is too low, or both.
Hence, investors tend to review a company’s financial statements with net income to determine the financial health of the company they’re investing with. Also, knowing the net income of a company is relevant to investors, because businesses use net income to calculate their earnings per share (net income divided by the number of outstanding shares). Hence, a low net income would mean low Earnings per share.
The net profit margin, on the other hand, shows us in percentage, the profitability status of a company. It shows us if a company is making money or not and gives an insight into the portion of the company’s sales that is turned into profits. The net margin tells us the amount of cents per dollar that the company generates per sale. Hence, calculating a company’s net profit margin enables analysts and investors to evaluate the financial health and profit level of a company.
As a profitability ratio, the net profit margin tells us how efficient a company is at converting revenue into profit. It can be used by investors to compare a company’s performance across reporting periods and among its competitors. If a company undergoes a strategic initiative to increase its profitability, then investors can calculate the net profit margin to ascertain whether the initiative is delivering results. If the net profit margin of the company is in decline, then investors can use this information to recognize deteriorating financial health.
Therefore, a company with a higher net profit margin than those of its peers indicates that the company is more efficiently converting revenue into profit. But if a company’s net profit margin is lower than those of its industry peers, then it could be a sign that the company is financially weaker or less efficient than its competitors.
Differences between net income and net profit margin
| Factors for comparison | Net Income | Net profit margin |
|---|---|---|
| Definition | Net income is a business’s total revenue minus its cost of goods sold, operating expenses, other expenses, depreciation, amortization, interest, and taxes for an accounting period | The net profit margin is a profitability ratio that shows how much net income (or net profit) is generated as a percentage of revenue |
| How is it calculated? | It is a figure that is calculated by subtracting all a company’s expenses from its total revenue (or Net sales) | It is a ratio that is derived by comparing a company’s net income to its total revenue (or Net sales) |
| Also known as | Total comprehensive income, Net earnings, Net profit, Bottom line, or Sales profit | Net profit margin ratio, Net income margin, or Net margin |
| Interpretation | The net income shows the total cash inflow of revenue for a specific accounting period after deducting expenses | The net margin shows the percentage of a company’s profits as compared to the total amount of money that it brings in. It also shows how effectively the company operates |
| Formula | Net Income = Revenue – Total Expenses | Net profit margin = Net income / Revenue |
| Dependency | The net income is dependent on revenue and expenses | The net profit margin is dependent on net income and total revenue |
| Position on the income statement | The net income is listed as a line item (bottom-line figure) on the income statement | The net profit margin is not listed as a line item on the income statement but is usually calculated using the Net income (bottom-line figure) and Revenue (top-line figure) found on the income statement |
| Uses | Net income can be used to calculate earnings per share for investors and some profitability ratios like Net profit margin, Return on assets (ROA), Return on equity (ROE), and Return on invested capital (ROIC) | Net profit margin is used to assess the profitability of a company as a percentage of profit that the company produces from its total revenue. It shows the amount of net income or net profit that the company obtains per dollar of revenue generated |
| Example | A $10,000 net income means that the company has $10,000 left after paying all the company’s expenses | A 33% net profit margin means that the company makes $0.33 as profit for every $1 generated as revenue. |
Related: Debt to EBITDA ratio formula and calculation
Net income vs net profit margin similarities
- One of the similarities between net income vs net profit margin is that they are both key metrics that are used to assess the financial health and profitability of a business.
- The deduction of all expenses from the company’s total revenue is a factor that is used in calculating both a net income and a net profit margin.
- The net income and net profit margin include all the factors that influence profitability.
- Another similarity between net income and net profit margin is that a high figure of net income and net profit margin ratio both indicates the more effectiveness of a company at cost control.
- A company’s net income and net profit margin can both be positive or negative figures. A negative net income or net profit margin arises when a company records a loss on the income statement for the accounting period.
- A negative net income and net profit margin both mean that the company or business was unprofitable during the reporting period.
- One of the similarities between net income vs net profit margin is that they are both susceptible to manipulation through such things as hiding expenses or aggressive revenue recognition. Therefore, when basing an investment decision on any of these figures, investors should review the quality of the numbers used to arrive at the taxable income and net income.
- After calculating a company’s net income or net profit margin, the resulting figure tells us about the profitability of a company.
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