Enter revenue, cost of goods sold, operating expenses, interest and a tax rate. You get net profit in dollars, net margin, and the gross and operating figures above it so you can see where the money left.
Net profit is the only figure on the income statement that nobody can argue about, because it is what the bank balance is supposed to agree with. Every margin above it involves a judgement about where to draw a line. This one does not.
Operating profit stops at the cost of trading. Three things sit underneath it, and they have nothing to do with how well the business sells.
Interest. The cost of how the business is financed rather than how it operates. Two identical companies, one funded by equity and one by a loan, will report the same operating profit and different net profit. That is the point of keeping them separate.
Tax. Charged on profit, not on revenue, so it scales with success and disappears in a loss year. The rate in the calculator above is a single blended figure, which is a simplification. Real tax involves allowances, carried-forward losses and timing differences that no browser calculator should pretend to model.
One-off items. The sale of an asset, a legal settlement, a write-off of dead stock. They land in net profit and distort it badly, which is why a single quarter of net margin tells you very little on its own.
The practical consequence is that net margin is the least useful number for operational decisions and the most useful one for judging whether the business as a whole is viable. Those are different questions and they need different lines of the statement.
| Line | Amount | % of revenue | Running total |
|---|---|---|---|
| Revenue | $37,410 | 100.0% | $37,410 |
| Cost of goods sold | $21,698 | 58.0% | $15,712 |
| Operating expenses | $12,850 | 34.3% | $2,862 |
| Interest | $180 | 0.5% | $2,682 |
| Tax at 21% | $563 | 1.5% | $2,119 |
Read the right-hand column as a drain. Revenue enters at $37,410 and $2,119 survives. Fifty eight cents of every dollar went on goods, thirty four on running the business, two on interest and tax. What is left is 5.7 percent, and $10,000 of that operating expense line was advertising.
The shape matters more than the total. The largest single leak is cost of goods, which is a sourcing and pricing problem. The second is operating expenses, of which advertising is 78 percent, which is a media problem. Interest and tax together took less than the rounding error on the first two.
The temptation is to take net margin, invert it, and use the result as a break-even ROAS target. At 5.7 percent net margin that gives a required return of 17.5x, which would shut down almost every advertising account in existence.
The error is double counting. Advertising is already inside operating expenses, so it has already been subtracted before net profit appears. Building a ROAS target on a number that has the ad spend removed charges the same dollar twice.
Break-even ROAS is set by gross margin, not net margin. In this example that is one divided by 0.42, which is 2.38x. Net margin answers a different question: whether the business as configured, at its current volume and cost base, ends the month with more money than it started with.
Use gross margin to decide what to bid. Use net margin to decide whether the whole operation is worth continuing.
Gross margin decides what you can bid. Net margin decides whether the business is worth bidding for.
Net profit is the number founders quote and the number that moves for reasons unrelated to the business. A tax credit lands, a piece of equipment gets sold, a supplier settles a dispute, and net margin doubles in a quarter where nothing about the trading improved. The reverse happens just as often and gets treated as a crisis.
The second trap is scale blindness. Net margin is a ratio, so a business doing $40,000 a month at 5.7 percent and one doing $400,000 at 5.7 percent look identical on the chart. They are not remotely the same business. The first keeps $2,100 and has no margin for error; the second keeps $21,000 and can absorb a bad month. Always read the margin and the dollar figure together, which is why both are on this page.
The third is timing. Net profit is an accounting result, not a cash result. A profitable month can still leave the account emptier if stock was bought ahead or a large customer pays on sixty day terms. Profit and cash are two different questions, and the bank only answers the second.
No. Net profit is an accounting result for a period; cash depends on when money actually moves. Buying stock ahead of a season or selling on sixty day terms can leave a profitable month with less cash than it started with.
No. Advertising sits inside operating expenses and has already been deducted before net profit, so building a target on net margin charges the same dollar twice. Break-even ROAS comes from gross margin.
It depends entirely on the business. Grocery retail is healthy at two percent; software at two percent is not. Read the trend across several quarters rather than any single figure, and read the dollar amount next to the percentage.
Usually stock, receivables or loan repayments. Repaying the principal on a loan reduces cash without touching the income statement, and inventory bought is cash gone that appears as an asset rather than a cost until it sells.