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Net Profit Ratio

This ratio indicates the relationship between the net profits and net sales. It is computed by dividing the net sales. It is expressed as a percentage. The formula is:

Net Profit Ratio = Net Profit / Net Sales x 100

The two components of this ratio are : (i) net profit and (ii) net sales. The net profit may be taken either before tax or after tax. The primary objective fo this ratio is to measure the overall profitability position of the business firm due to operational efficiency and non-operating profits and losses. Interpretation. A high net profit ratio would enable to firm (i) to pay higher dividends (ii) to create adequate general reserves and (iii) to face bad economic conditions such as declining sales price or rising cost of production and falling demand for its products. A low net profit ratio has opposite result. But a firm with a low profit margin can earn a high rate of return on investments if it has higher sales turnover. A fall in the net profit ration would require a through investigation into the operating expenses if there has been unreasonable increase of such expenses.

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