Gross margin is one metric of profit margin, one of three profitability ratios used to evaluate the financial state of a company.

Profit margin is the ratio, or percentage, of profit that a company retains after deducting costs from sales revenue. Expressing profit in terms of a percentage of revenue, rather than just stating a dollar amount, is more helpful for evaluating a company's financial condition. If a company's $500,000 profit reflects a 50% profit margin, then the company is in very solid financial health, with revenues well above expenses. If that $500,000 is a mere 1% over the company's total costs and expenses, then the company is barely solvent and just the slightest increase in costs may be sufficient to push the company into bankruptcy.

Profit margin often refers to net profit margin, the bottom-line percentage of revenues the company earns beyond the total of all its costs and expenses. To provide a more detailed analysis, profit margin is examined on three levels: gross profit margin, operating profit margin and net margin. The gross profit margin is calculated only by deducting from revenue the direct production-related costs, such as component parts and packaging. Gross margin provides an indication of how cost-efficiently a company produces the items it sells, and it shows how much of each dollar in sales revenue a company has left for other expenses, such as marketing and research, which are important factors in determining a company's ability to grow and expand. Since production costs tend to be relatively fixed and do not vary greatly from year to year, gross margin provides a solid baseline measurement of profitability. Operating margin is the profit calculation between gross margin and net margin, which includes all expenses except taxes and interest. It helps in analyzing more variable costs – wages, advertising, and other administrative expenses – and shows the performance of the company's owners in the overall running of the business.

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  2. What is the difference between gross profit margin and operating profit margin?

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  3. What is the difference between operating margin and contribution margin?

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  4. What costs are not counted in gross profit margin?

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