Gross Margin vs. Profit Margin: An Overview

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.

Key Takeaways

  • Both gross profit margin and net profit margin are used to determine how efficient a company's management is in earning profits.
  • The gross profit margin provides an indication of how efficiently a company produces its goods given the costs involved.
  • The gross profit margin is calculated by deducting from the revenue the costs associated with the production, such as parts and packaging.
  • The net profit margin is the bottom line of a company in percentage terms and is the ultimate measure of profitability for a company.
  • The net profit margin is calculated by deducting from the gross profit operating expenses and any other expenses, such as debt.

Gross Profit Margin

The gross profit margin is the percentage of the 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 the production.

The gross profit margin is calculated by subtracting the 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 other companies within the same industry to determine whether the trend is improving or if Apple's gross profit margin exceeds those of its peers.

It's useful to analyze the margins of companies over time to determine any trends and to compare the margins with companies in the same industry. 

Net Profit Margin

When investors and analysts refer to a company's profit margin, they're typically referring to the net profit margin. The 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.

The 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.