After-Tax Profit MarginHow much net income is your business earning for every dollar of gross or net revenue?

The primary purpose of starting and operating a business is to earn profits.

The more profits that your business earns, the better.

But how can you tell if your business is earning “more”?

Let’s say that for the current year, your business earned $5,000 more compared to your competitors.

Does that mean that your business is earning “more”?

Well, in dollar terms, it certainly is.

However, it isn’t always about the dollar amount.

You also need to pay attention to the efficiency of your business’s operations.

Let’s expound on our example above.

Let’s say that your business makes a $25,000 profit from a revenue of $50,000.

One of your business’s competitors makes a $20,000 profit from a revenue of $30,000.

Just looking at the dollar amounts, we can tell that your business is able to earn more profit.

However, if we look at how much profit each business makes for every dollar of revenue, the competing business fares better.

If it is able to generate the same level of revenue, assuming that it can maintain the same level of efficiency, it will be able to earn more profit than your business.

This is why measures of efficiency are important for any business owner.

Among these measures of efficiency are the profit margins such as gross margin, operating margin, and after-tax profit margin.

In this article, we will be talking about what the after-tax profit margin is.

Basically, the after-tax profit margin measure how much net income a business earns for every dollar of gross or net revenue.

What is an after-tax profit margin?

What information does it tell us?

How important is it for a business?

How does one calculate an after-tax profit margin?

We will try to answer these questions as we go along with the article.

What is the After-Tax Profit Margin?

The after-tax profit margin (a.k.a. net profit margin) is an efficiency ratio that expresses a business’s net income as a percentage of its gross or net revenue.

We calculate it by dividing the business’s net income by its gross or net revenue.

It is an important measure as it informs us of well a business control its costs.

The higher the after-tax profit margin is, the better the business is controlling its costs.

That’s not to say though that a low after-tax profit margin is necessarily a bad sign.

Some businesses within certain industries will naturally low after-tax profit margins.

This is because these businesses have high costs of operations.

The after-tax profit margin is also a useful comparison tool.

A business can compare its current after-tax profit margin with one of its previous periods to see if maintaining its control of costs or improving it.

The business can also compare its current period after-tax profit margin with the targeted margin to see if it was able to hit its target.

Lastly,  the business may compare its after-tax profit margin with another business that is within the same industry to see how relatively well it’s doing in controlling costs.

Investors value the after-tax profit margin because it shows how good a business is in converting its revenue into net profit or net income (which is the main source of dividends for shareholders).

Others even use it for comparative analysis to determine which stock gives the better bang for the buck.

Do note that the after-tax profit margin alone isn’t enough to provide an exact measure of a business’s financial well-being.

It should be used in conjunction with other performance measures to arrive at a more accurate measure of the business’s operational effectiveness and efficiency.

The After-Tax Profit Margin

To calculate a business’s after-tax profit margin, we simply calculate the net income by the gross or net revenue.

Using net revenue as the denominator is preferred. In formula form, it should look like this:

After-Tax Profit Margin = Net Income ÷ Net Revenue

Net Income

Net income is the profit that a business after deducting all expenses (including taxes) from the revenue.

This means deducting the cost of sales or cost of goods sold (e.g. direct labor, direct materials, manufacturing overhead), operating expenses (e.g. salaries and wages, rent), non-operating expenses (e.g. interest expense), and taxes from all revenues (operating and non-operating).

On a typical income statement, we can find the net income at the last or bottom line item.

Net income is the main source of dividends that a business distributes to its shareholders.

Usually, if a business is unable to generate a positive net income during a certain period, it is unlikely to declare and distribute dividends for that period.

Net Revenue

Net revenue is the figure we arrive at after deducting returns, allowances, and discounts from the gross revenue.

It also factors in the deductions due to damaged, stolen, and/or missing products.

If the business doesn’t have any of these deductions, the net revenue should be equal to the gross revenue.

Net revenue is a better denominator than gross revenue when calculating the after-tax profit margin.

This is because the net revenue represents how much revenue the business truly earned for a certain period.

Net revenue can assist in identifying the inefficiencies in a business’s loss prevention.

If net revenue is significantly lower than gross revenue, something is definitely wrong with the business’s loss prevention.

After-Tax Profit Margin: Example

You own a business. In its latest ended accounting period, your business was able to generate a net income of $25,000 from its net revenue of $50,000.

Let’s calculate your business’s after-tax profit margin:

After-Tax Profit Margin = Net Income ÷ Net Revenue

= $25,000 ÷ $50,000

= 0.5 or 50%

As per our calculation, your business’ after-tax profit margin is 0.5 or 50%.

This means that it was able to generate $0.50 net income for every $1 of net revenue.

Now let’s say that for the current period, your business earns $40,000 net profit from net revenue of $60,000.

Let’s calculate the current after-tax profit margin:

After-Tax Profit Margin = Net Income ÷ Net Revenue

= $40,000 ÷ $60,000

= 0.667 or 66.67%

As per our calculation, the current after-tax profit margin is 0.667 or 66.67%.

This means that the business earned $0.67 net income for every $1 of net revenue.

Note that the percentage increased.

This is because there’s a disproportionate growth between net income and net revenue.

Net income increases by $15,000 while net revenue only increases by $10,000.

Since net income has increased more, it could mean that your business is able to better control its costs.

After-Tax Profit Margin vs the Other Profit Margins (e.g. gross margin, operating margin)

Among all the profit margins, the after-tax profit margin is probably the most conservative.

After all, it considers all expenses (including taxes) in its calculation.

The gross margin only considers the cost of sales, while the operating margin only considers the cost of sales and operating expenses.

Naturally, the two profits margin should have a higher figure than the after-tax profit margin.

A potential downside to the after-tax profit margin is that isn’t a good comparison tool if there are varying tax rates between the two variables.

For example, the tax rate for the current period is 32% while for the previous period, it was 35%. In cases like this, it’s better to use the pre-tax profit margin as a comparison tool.

The pre-tax profit margin uses pre-tax profit (or earning before taxes) as the numerator instead of the net income.