If you're looking to expand or grow your business, one of the first steps you need to take is to learn to understand your net income ratio. We're going to talk about what is net income ratio, and why is it's important for your business.
What is Net Income Ratio?
Your net income margin ratio is also known as your profitability ratio, which is the percentage of profit that incurred from business operations after expenses, interest, taxes, and dividends are deducted—the bottom line. The net income ratio essentially indicates how the company converts sales to profits—less expenses. This is used to measure both efficiency and overall cash flow, working capital, and financial health.
For example, companies that generate more profit per dollar of sales are more efficient, and businesses with high net income ratios are in better positions to expand or launch a new product line, and also survive in the event of failure.
Why is Net Income Ratio Important?
As mentioned above, the net income ratio is a good source of measurement to help determine the overall financial position and health of a business. It can also help business owners analyze and verify financial results at different time periods to help identify any existing trends.
In another example, a comparative analysis can help identify profit areas that have decreased, or expenses or other costs that have increased, reducing net income.
However, it’s important to note that although the net income ratio can be incredibly valuable for businesses, this data can differ between industries and companies. Therefore, the net income ratio should not be compared across industries or used for benchmarking. Rather, it is better to compare the net income ratio with similar businesses, regarding size, shape, scope, and model.
Net Income Ratio Formula
So, how is net income ratio calculated? To find out what your net income ratio is, divide net profit or net income by net sales, and then multiply by 100. The formula is:
(Net income ÷ Net sales) x 100
Here's an example:
Say that a company, Button Landscaping had $50,000 in net sales last month. After expenses and taxes are deducted, net income was $25,000.
The calculation of Button Landscaping's net profit percentage is:
($25,000 ÷ $50,000) x 100 = 50%
How to Increase Your Net Income Ratio
Now that you understand more about the net income ratio, how it works, and why it is so important, how do you increase it? If you did a few quick calculations while reading this article, and you are now concerned with your net income ratio results, don’t worry. Here are three ways to get your ratio back to where you want it to be.
1. Reduce Expenses – After reviewing your net income ratio, and seeing how your company’s expenses affect your bottom line, one of the best ways to improve this is to reduce costs. This could include reducing operating expenses, such as taking some of the following actions:
- Reducing labor costs with outsourcing
- Implementing more efficient operations by adopting technology solutions
- Implementing effective operations
- Cancelling or removing unused or outdated services
- Recycling or “going green”
- Focus on optimizing your marketing, so you're paying less per customer.
2. Increase Sales and Income – Although it might sound easy, if you are in business you know increasing sales and revenue isn’t as easy as flipping a light switch, nor can it be done overnight.
If you want to increase sales and revenue, then this will likely involve investing in a solid marketing strategy, reviewing your current sales methodology or even launching a new product line or entering a new market.
3. Reduce Receivables Expense – Although we already talked about reducing operating and overhead costs, another option is to reduce receivables expense. This means reducing
What You Should Know about the Net Income Ratio
It's important for businesses to monitor their net income ratios, especially if they plan on expanding, growing or launching a new product line along with financial liquidity. Monitoring overall financial health is the best way to ensure growth. However, the net income ratio is a short-term measurement. It can help business owners identify key financial trends and patterns, but it does not reveal a company's ability (or inability) to maintain profitability over the long term.
As a result, it’s important for businesses to evaluate the net income ratio along with other key performance metrics to gain a bigger, clearer picture of the company’s financial stability and position.