Net Profit Ratio
The net profit ratio establishes the ratio between net profit (after taxes) and sales, and indicates the efficiency of the management in manufacturing, selling administrative and other activities of the firm. It gives the measure of net income each rupee of sales generates. This ratio gives an overall measure of the firm's profitability and is calculated as follows:
The two basic elements of the ratio are net profits and sales. The net profit will be obtained after deducting income tax. The ratio is very useful because if the profit is not sufficient, the firm shall not be able to achieve a satisfactory return on its investment.
This ratio also indicates the firm's capacity to face adverse economic conditions such as price competition, low demand, etc. Obviously, higher the ratio, the better is the profitability. While it is desirable to have a high ratio, economic conditions, competitive forces within an industry, capital structure of particular firm and high fixed costs cause the net profit ratio to vary from industry-to-industry.
But while interpreting the ratio, it should be kept in mind that the performance of profits must also be seen in relation to investment or capital of the firm and not in relation to sales alone.
Several refinements to net profit ratio exist. The numerator is refined by deducting the 'other income' and 'other expenses', since it is argued that these items cause distortion in interpreting the ratio as they do not relate to net sales, which is considered as the denominator.
Following figures are extracted from the Profit and Loss account of Infosys Ltd.
Net Profit Ratio of Infosys Technologies Ltd. for the years 2006 and 2005 is given below:
(Rs. in Crore)
|
|
2006-07
|
2005-06
|
|
Net Profit after tax but before exceptional items
(Rs. in crore) (A)
|
3,777
|
2,421
|
|
Net Profit after tax and exceptional items
(Rs. in crore) (B)
|
3,783
|
2,421
|
|
Net Sales/Revenue (Rs. in crore) (C)
|
13,149
|
9,028
|
|
Net Profit Ratio before exceptional items (A) ¸ (C) x 100
|
28.72%
|
26.82%
|
|
Net Profit Ratio after exceptional items (B) ¸ (C) x 100
|
28.77%
|
26.82%
|
The net profit ratio has increased from 26.82% to 28.77%. The average industry net profit ratio is 21.8% (CMIE Monthly Industry Analysis). It is more than the industry average. The company's overall performance is quite good.
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