Net profit margin is net profit divided by revenue, times 100. The figure only means something once you know which profit is used: before interest and tax, before tax, or after tax. To compare businesses fairly you also need to adjust for how the owners are paid, how the business is financed and whether it is a sole trader or a company.

How is net profit margin calculated?

The basic formula is net profit divided by revenue (turnover excluding VAT), multiplied by 100. The trouble is the word “net”. ACCA’s ratio analysis article defines operating profit margin as profit before interest and tax divided by revenue, and notes that it is sometimes known as net profit margin. Others use profit before tax, and statutory accounts end with profit after tax. Each gives a different percentage from the same accounts, so always state which you used. The different profit lines are explained in gross, operating and net profit.

What does a worked example look like?

Illustration only. A company with a 12 month accounting period and no associated companies, assuming taxable profit equals accounting profit:

Amount % of revenue
Revenue £400,000 100%
Gross profit £160,000 40%
Overheads (£112,000)
Operating profit £48,000 12%
Interest (£4,000)
Profit before tax £44,000 11%
Corporation tax at 19% (£8,360)
Profit after tax £35,640 8.9%

The same business can honestly be described as having a 12%, 11% or 8.9% net margin. GOV.UK gives the small profits rate of 19% for profits of £50,000 or less, the main rate of 25% for profits over £250,000 and marginal relief in between, so after tax margins of two otherwise identical companies differ if their profits sit in different bands. See marginal relief.

What affects net profit margin?

  • Gross margin: prices, purchase costs, discounts, wastage and sales mix. See gross margin vs markup.
  • Overheads: premises, staff, marketing, professional fees and depreciation.
  • Volume: because many overheads are fixed, margin rises faster than sales when volume grows and falls faster when it shrinks.
  • Financing: interest reduces profit before tax but not operating profit, so a heavily borrowed business looks worse on a pre tax margin than on an operating margin.
  • Tax, for after tax margins.
  • One off items, such as a profit on selling a property or a large bad debt, which distort a single year.

Margin also has to be read with asset use. ACCA shows that return on capital employed equals operating profit margin multiplied by asset turnover, so a 5% margin with asset turnover of 2 gives a 10% return. ACCA adds that retailers generally combine high asset turnover with low margins. A low margin is not a weak result if the business turns its assets over quickly.

Why is it hard to compare small businesses?

The biggest distortion is how the owner is paid. A sole trader’s net profit is before any reward for the owner, because drawings are not an expense; see drawings for sole traders. A company deducts directors’ salaries and pension contributions but not dividends, and the split between the two is a tax choice; see salary vs dividends.

HMRC deals with this in its Enquiry Manual. EM3093 measures net profitability to turnover as net profit over turnover for an unincorporated business, but for a company adds back directors’ remuneration and directors’ pension contributions before dividing by turnover. EM3094 suggests adding directors’ remuneration to profit when comparing a small close company, whose shareholders are all directors, with an unincorporated business.

Illustration only. Two identical cafes each have revenue of £200,000 and earn £60,000 before paying their owners. The sole trader reports a 30% net margin. The company pays its director £40,000 including pension and employer costs and reports £20,000, a 10% margin. Add back the director’s pay and both show 30%.

Other adjustments worth making before comparing: leasing instead of buying (rent in overheads rather than depreciation and interest), owner occupied premises with no rent charge, family members working unpaid, and different depreciation policies.

Where can you find comparable figures?

Public accounts are less useful than they look. Under section 444(1) of the Companies Act 2006, a company subject to the small companies regime must file a balance sheet but may choose whether to file its profit and loss account, so most small companies’ margins are not on the register. The government’s transition plan for the Economic Crime and Corporate Transparency Act says that from April 2028 Companies House should be able to require small companies and micro entities to file profit and loss accounts, with an option to opt out of publishing that information on the public register.

Official statistics measure something different. The ONS measures company profitability as a net rate of return on capital employed, not a margin on sales. Its bulletin released on 28 November 2025 gave a 2024 rate of 10.3% for private non financial corporations as a whole, 11.7% for manufacturing and 15.2% for services. These figures show how profitability varies by sector but cannot be compared directly with a margin.

The most reliable comparison is usually the business’s own history. EM3100 shows HMRC indexing turnover, gross profit, net profit and remuneration to a base year and comparing them with inflation, to see whether net profit is keeping pace with sales. The same approach works for an owner reviewing a five year trend. For other measures to track alongside margin, see KPIs for small businesses.

How does HMRC use net margin?

EM3093 says that in a high turnover retail trade you would expect a very low net profit ratio, while the same figure would be disastrous in a capital intensive business with slow stock turnover. It also says that if turnover has risen but gross margins were squeezed to achieve it, net margins would be expected at least to hold steady, and that the effect of under declared income is much more marked on net profit than on gross profit because net profit is a smaller figure. A falling net margin with no commercial explanation is something an HMRC officer may ask about.

What mistakes come up most often?

  • Not saying which profit is used, then comparing an operating margin with an after tax margin.
  • Comparing a sole trader with a company without adjusting for owner pay.
  • Using VAT inclusive turnover as the denominator.
  • Judging one year in isolation when one off items or a change in mix explain the movement.
  • Reading margin without asset turnover, which penalises low margin, high volume businesses.
  • Using a sector average from a different size of business, where overhead structures differ.

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Sources

Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.