A:

Gross margin and profit margin are profitability ratios used to assess the financial health of a company. Both gross profit margin and profit margin – more commonly known as net profit margin – measure the profitability of a company as compared to the revenue generated for a period. Both ratios are expressed in percentage terms but have distinct differences between them.

Profit margin is a percentage measurement of profit that expresses the amount a company earns per dollar of sales. If a company makes more money per sale, it has a higher profit margin.

Profit margin is the 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 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.

Gross Profit Margin

Gross profit margin is the percentage of company's revenue that exceeds its cost of goods sold. It measures the ability of a company to generate revenue from the costs involved in production.

The gross profit margin is calculated by subtracting cost of goods sold from revenue. The COGS is the amount it costs a company to produce the goods or services that it sells. 

Example of Gross Profit Margin

Below is the income statement for Apple Inc(AAPL) as of March 31, 2018:

  • Apple's net sales or revenue was $61B, and their cost of sales or cost of goods sold was $37.7B for the period. 
  • Apple's gross profit margin: ($61B - $37.7B) / $61B = 38%

It's helpful to compare the quarter's profitability to prior quarters and to company's within the same industry to determine whether the trend is improving or if Apple's gross profit margin exceeds those of its peers.

Net Profit Margin

When investors and analysts refer to a company's profit margin, they're typically referring to net profit margin. Net profit margin is the percentage of net income generated from a company's revenue. Net income is often referred to as the bottom line for a company or the net profit.

Net profit margin shows whether increases in revenue translate into increased profitability. Net profit includes gross profit (revenue minus cost of goods) while also subtracting operating expenses and all other expenses, such as interest paid on debt and taxes. 

Example of Net Profit Margin 

As of March 31, 2018, Apple's net sales or revenue was $61B, and its net income was $13.8B for the period.

Apple's net profit margin: $13.8 billion ÷ $61 billion = 23%

A net profit margin of 23% means that for every dollar generated by Apple in sales, the company kept $0.23 as profit.

Takeaways

Gross profit margin and net profit margin are used to determine how efficiently a company's management is in earning profits. It's important to analyze the margins of companies over time to determine any trends and to compare the margins with companies in the same industry.  

The gross profit margin is calculated only by deducting from revenue the direct costs involved in production, such as parts and packaging. Gross margin provides an indication of how efficient a company produces its goods given the costs involved. The net profit margin is the bottom line of a company in percentage terms and is the ultimate measure of profitability for a company. For more on the formulas and calculating profit margins, please read "What's the Difference Between Gross Profit Margin and Net Profit Margin?"

RELATED FAQS
  1. How does gross margin and net margin differ?

    Gross margin or gross profit margin and net profit margin are both profitability ratios used in determining the financial ... Read Answer >>
  2. What is the difference between operating margin and contribution margin?

    Understand the difference between two measures of profitability, operating margin and contribution margin, and the purpose ... Read Answer >>
  3. Profit margin versus operating margin: What's the difference?

    There are some distinctions between profit margin and operating margin. Both measure efficiency of a firm, but one takes ... Read Answer >>
  4. What is considered a healthy operating profit margin?

    An operating profit margin is a profitability ratio that investors use when evaluating a company. Comparing a company's margins ... Read Answer >>
  5. What is the difference between revenue and cost in gross margin?

    Discover the differences between revenue and cost in gross margin, along with an explanation of various measures of profitability. Read Answer >>
  6. What is the formula for calculating profit margins?

    Learn about gross, operating and net profit margins, how each is calculated and how they are used by businesses and investors ... Read Answer >>
Related Articles
  1. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
  2. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  3. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look when it comes to your profit margin.
  4. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  5. Investing

    3 Profit Metrics Every Investors Should Understand

    In this article, you will understand how the three metrics gross profit, operating profit, and net profit helps investors see how a company is performing.
  6. Investing

    Is Net Income The Same As Profit?

    Net income and profit both deal with positive cash flow, but there are important differences between the two concepts.
  7. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
RELATED TERMS
  1. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
  2. Gross Profit Margin

    A gross profit margin is a financial metric used to assess financial ...
  3. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  4. EBITDA Margin

    EBITDA margin is a measurement of a company's operating profitability ...
  5. Segment Margin

    Segment margin is the amount of profit or loss produced by one ...
  6. Sales Mix

    The sales mix is the relative amounts purchased of each of the ...
Trading Center