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The Difference Between Gross Margin and Profit Margin

What’s the difference between gross margin and profit margin?

It’s no secret that financial management can get a little complicated at times. But knowing your numbers is one of the most crucial parts of running a successful organization. 

Two of the most critical concepts to understand are gross margin and net profit margin

However, many business owners aren’t completely clear on what these terms mean and how they’re used. 

Let’s take a closer look to help you understand everything you need to know.

Net Profit Margin 

The first thing you should understand about both of these concepts is that “margins” usually refer to percentages. 

When evaluating or calculating a company’s margins, you’ll usually start by looking at the organization’s net profit or net income. 

In the simplest terms, net profit or net income is calculated as revenue minus expenses. 

Net profit or Net income margin can then be found by dividing net profit by revenue. This is how you get the percentage. 

Examples

Let’s look at Apple’s recent financial statements to calculate its net profit margin. 

In 2021, Apple’s revenue was $365 billion with a net income of $95 billion. Dividing net income by revenue gives a 26% net profit margin. In other words, for every one dollar of revenue Apple received, 26 cents of it was profit. 

At the same time, Google’s revenue was $257.6 billion with a net income of $76 billion. Dividing net income by revenue gives a 30% net profit margin. In other words, for every one dollar of revenue Google received, 30 cents of it was profit. 

Therefore, you can see that Google was more efficient at generating a profit.

Gross Profit 

Gross profit is a similar concept with some important distinctions. To calculate gross profit, you take a company’s revenue and subtract the expenses used to generate that revenue. This differs from net profit in that you’ll only deduct expenses directly related to creating the revenue, as opposed to all of the organization’s expenses.

The exact expenses that should be considered as helping generate revenue will vary from company to company and industry to industry. 

For example, businesses that sell a physical product can deduct the cost of goods sold, while service companies can deduct their payroll expenses.

Why is Gross Profit Important?

Gross profit is one of the best gauges of the overall health of a business. A large gross profit means that not only are your direct business costs low, but that you also have money left over to cover other expenses. 

Conversely, a smaller gross profit may be a sign of an inefficient business or one that needs to more carefully manage how it generates revenue and spends money.

Example

Let’s look at two businesses – Company A and Company B. 

Company A has $1,000 in sales and spends $500 on the cost of goods sold (COGS), resulting in a gross profit of $500. 

Company B also has sales of $1,000 but a COGS of $800. This gives Company B a gross profit of $200. 

Obviously, most investors would prefer to be involved with Company A since it’s making more groos profit on the same amount of sales.

Gross Profit Margin

Now that you understand gross profit, you can easily calculate and understand gross profit margin. 

It’s expressed as a percentage and calculated by dividing gross profit by revenue. Like net profit margin, it gives insight into the efficiency of how an organization makes money.

Examples

Returning to our earlier examples, let’s look at Apple and Google. 

Apple reported a gross margin of roughly $152 billion and revenue of $365 billion. This translates to an approximately 42% gross profit margin (GPM.) 

At the same time, Google saw $147 billion in gross margin on revenue of $258 billion, a 57% gross profit margin

Therefore, Google’s higher gross profit margin suggests it’s better than Apple at creating profit from its business operations.

Spotting Net and Gross Profit Margin on Your Financial Statements

Financial statements can be a bit difficult to navigate, especially for those who don’t do so regularly. So here are a few tips: 

  • If you’re looking for net profit, you’ll typically find it at the bottom of a profit and loss statement. 
  • If you’re looking for gross profit, you’ll typically find it in the middle of a P&L. 

This simple rule of thumb can save you quite a bit of time searching statements for the information you need!

Need Extra Help Spotting the Difference?

Understanding and calculating gross profit margin and net profit margin is fairly straightforward once you learn the difference. 

However, taking that information and putting it into context can be tricky. But don’t worry – Vertical CPA is here to help. 

Our experienced professionals can walk you through your numbers and find strategies to boost gross profit margins and other key metrics. Contact us today to learn more!

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