What is Net Income Margin?

Net income margin is the net after-tax income of a business, expressed as a percentage of sales. It is used in ratio analysis to determine the proportional profitability of a business. It is especially useful when tracked on a trend line, to see if there are any spikes or dips in the long-run average net income margin. An outside analyst can use this information as part of an analysis to decide whether to recommend to investors whether a company's shares should be bought or sold.

How to Calculate Net Income Margin

To calculate net income margin, divide net income by sales. Net income should be net of all expenses, including taxes, interest, and non-operating expenses. The sales figure used in the denominator should be net sales, which is gross sales minus all sales returns and allowances. The net income margin formula is as follows:

Net income ÷ Sales = Net income margin

Example of Net Income Margin

ABC International has net after-tax income of $50,000 and sales of $1,000,000. Its net income margin is calculated as follows:

$50,000 Net income ÷ $1,000,000 Sales = 5% Net income margin

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Problems with the Net Income Margin

There are several problems with the net income margin, which are as follows:

Immaterial amount. The net income percentage is usually such a small percentage of the total activity of a business that it can be easily altered by one-time expenses. For example, an unexpected repair bill could take a large chunk out of the expected percentage.
No link to cash flows. Another issue is that this ratio does not necessarily match the amount of cash flow generated by a business, especially if results are being presented using the accrual basis of accounting; consequently, it may be necessary to compare the net income margin to the cash flows information on the statement of cash flows.
Subject to accounting shenanigans. Even modest accounting manipulations made by the accounting staff can result in significant variations in the amount of net income margin reported. Consequently, this margin may not be reliable when management is determined to alter reported results.
Too narrow a focus. The net income margin directs your attention solely to the outcome of financial operations for a reporting period, but does not factor in the impact of debt levels, the quality of assets, or changes in cash flows. Thus, it has an excessively narrow focus on only one part of a business.