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.
Example of Gross Profit Margin
- 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.
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?"