You’re invited to our Ardent Partners webinar: “Defend Your Margins: Seven CPO Strategies for 2023” in March.
Our analysis today focuses on net profit margin and how the large contribution from procurement should play amongst corporate executives. Procurement contribution can be the impact of savings or the benefits of demand management or the value of efficiencies or the positive effects of extending DPO or the contribution of cost avoidance (yes, cost avoidance, too) or it can be a combination of two or more or all of these things and/or any of the other ways that procurement can create financial value. For now, we will put aside the discussion of savings calculations, internal negotiations and processes. We will put aside the differences between realized and booked savings and the gap between the credit procurement gets for its efforts and the credit it deserves. Once I get a little further ahead of schedule in writing these articles, I promise to revisit the entire savings topic in a series of posts — it is a topic as interesting as it is confounding. Back to margins and leverage.
Net Profit Margin Definition
According to Investopedia
The ratio of net profits to revenues for a company or business segment – typically expressed as a percentage – shows how much of each dollar earned by the company is translated into profits. Net margins can generally be calculated as:
Investopedia continues by adding:
“Net margins will vary from company to company, and certain ranges can be expected from industry to industry, as similar business constraints exist in each distinct industry. A company like Walmart has made fortunes for its shareholders while operating on net margins less than 5% annually, while at the other end of the spectrum some technology companies can run on net margins of 15-20% or greater.
Most publicly traded companies will report their net margins both quarterly (during earnings releases) and in their annual reports. Companies that can expand their net margins over time will generally be rewarded with share price growth, as it leads directly to higher levels of profitability.”
To quickly summarize tells us three things:
- Most companies track and report net profit margins
- This metric differs by industry and company
- All things equal, companies with higher net profit margins are more valuable to investors.
The MSN Money Advisor advises that
Net margins can provide a sizeable competitive edge, so always compare them to the average for the industry. A company with higher net margins can spend more on product improvements or state-of-the-art factories. In an industry-wide downturn, a company with a low net margin even in good times might be forced to borrow just to meet costs and is almost certain to lose ground to more profitable competitors. Comparing net margins across the companies in an industry is also a good way to get a quick handle on the quality of management. Good managers should be able to wring more profit out of each dollar of sales (although an investor needs to make sure that management isn’t getting higher temporary profits by neglecting long-term investment in the business).
To quickly summarize tells us three more things:
- Net profit margins can indicate a competitive advantage within an industry
- Investors may look at net profit margin as an indicator of the quality of company management
- Net profit margins are important to investors and executives.
Net Profit Margin Example
Here is a quick hypothetical example that you can use to calculate your company’s net profit margin.
Assumptions: Ardent Partners sold 1,000,000 widgets for $10 each (revenue, therefore, equals $10,000,000), with a cost of goods sold of $5 each (COGS = $5,000,000). It had $2,500,000 in operating expenses, paid $500,000 in interest expense, and paid $1,000,000 in income taxes.
Net Profit = Revenue – COGS – Operating Expenses – Interest – Taxes
Net Profit = $10MM – $5MM – $2.5MM – $.5MM – $1MM
Net Profit = $1MM
Net Profit Margin = Net Profit divided by Revenue or $1MM divided by $10MM or 10%
So, Ardent|Partners has a 10% net profit margin.
As our example shows, Ardent|Partners had to earn $10 million in revenue to generate a net profit of $1 million.
Procurement impacts net profit margin in a variety of ways and scenarios. Understanding these calculations and presenting the numbers to execuitves, along with procurement’s contribution, can bring greater visbility to the function.
RELATED RESEARCH
Visibility into Savings, Spend, & Impact
Beyond Savings and Risk: Next-Gen Procurement Analytics is Coming into their Own
The Significance of Contract Management in Plugging Procurement’s Savings Leakage
Procurement Performance: Moving Beyond Savings
Tagged in: Chief Procurement Officer, CPO, Finance, Performance, Savings
