Gross margin and net margin are profitability ratios used to assess the financial well being of a company. Both gross profit margin and net margin or net profit margin are expressed in percentage terms and measure profitability as compared to revenue for a period.
- Profit margins are a measure of how efficient a company is at turning sales into profits by comparing revenues to costs of goods sold.
- Gross profit margin is computed by simply dividing net sales less cost of goods sold by net sales.
- Net profit margin further removes the values of interest, taxes, and operating expenses from net revenue to arrive at a more conservative figure.
A Tale of Two Margins
Gross profit margin is the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). COGS are raw materials and expenses associated directly with the creation of the company's primary product, not including overhead costs such as rent, utilities, freight, or payroll.
Gross profit margin is the gross profit divided by total revenue, multiplied by 100, to generate a percentage of income retained as profit after accounting for the cost of goods.
The net profit margin takes into account all business expenses, not merely COGS, and is, therefore, a more stringent metric by which to measure profitability. Net profit reflects the total revenue left over after accounting for all outgoing cash flow and additional income streams including COGS, other operational expenses, debt payments such as interest, investment income, income from secondary operations, and one-time payments for unusual events such as lawsuits and taxes.
Net profit is divided by total revenue and multiplied by 100 to yield a percentage of income that remains after all expenses.
Gross Profit Margin vs. Net Profit Margin In Practice
Let us look at these two profit margin measures using a historical example. Below is the income statement for Apple Inc. (AAPL) as of March 31, 2018:
- Apple's net sales or revenue was $61 billion, and their cost of sales or cost of goods sold was $37.7 billion for the period.
- Apple's gross profit margin was 38% or (($61 billion - $37.7 billion) ÷ $61 billion) x 100.
- As of March 31, 2018, Apple's net sales or revenue was $61 billion, and net income was $13.8B for the period.
- Apple's net profit margin was 23% or ($13.8 billion ÷ $61 billion) x 100.
A net profit margin of 23% means that for every dollar generated by Apple in sales, the company kept $0.23 as profit.
Gross profit margin (gross margin) and net profit margin (net margin) are used to determine how well a company's management is generating profits. It's important for investors to compare the profit margins over several periods and against companies within the same industry.