The Difference Between Gross and Net Profit Margin

Last week, we looked at how your profit margin can affect your place in the market. Today, we break it down for you and explain the profit margin in more detail. Knowing this ‘financial lingo’ will assist when analysing your profit and loss statement.

Gross Profit
Calculated as sales minus all costs directly related to those sales – COST OF GOODS SOLD (COGS). These costs can include manufacturing expenses, raw materials, labour, selling, marketing and other expenses.

Gross Profit Margin
What remains from sales after a company pays out the cost of goods sold. To obtain gross profit margin, divide gross profit by sales. Gross profit margin is expressed as a percentage. For example, if a company receives $25,000 in sales and its cost of goods sold were $20,000, the gross profit margin would be equal to $25,000 minus $20,000, divided by $25,000, or 20%. Basically, 20% gross profit margin means that for every dollar generated in sales, the company has 20 cents left over to cover basic operating costs and profit.

Net Profit
Often referred to as the bottom line, net profit is calculated by subtracting a company’s total expenses from total revenue, thus showing what the company has earned (or lost) in a given period of time (usually one year). Also called net income or net earnings.

Net Profit Margin
Net profit divided by net revenues, often expressed as a percentage. This number is an indication of how effective a company is at cost control. The higher the net profit margin is, the more effective the company is at converting revenue into actual profit. The net profit margin is a good way of comparing companies in the same industry, since such companies are generally subject to similar business conditions. However, the net profit margins are also a good way to compare companies in different industries in order to gauge which industries are relatively more profitable. Can also be called net margin.

For more information about financial reporting, contact Tradies Accountant today.