Gross margin and netmargin are profitability ratios used to assess the financial well beingof a company. Both gross profit margin and netmargin ornet profit marginare expressed in percentage terms and measure profitabilityas compared to revenue for a period.
Key Takeaways
- Profit margins are a measure of how efficient a company is at turning sales into profits by comparing revenues to costs of goods sold.
- Gross profit margin is computed by simply dividing net sales less cost of goods sold by net sales.
- Net profit margin further removes the values of interest, taxes, and operating expenses from net revenue to arrive at a more conservative figure.
A Tale of Two Margins
Gross profit marginis theproportion of money left over from revenues after accounting for thecost of goods sold(COGS). COGSare raw materials and expenses associated directly with the creation of the company's primary product, not including overhead costs such as rent, utilities, freight, orpayroll.
Gross profit marginis the gross profit divided by total revenue,multiplied by 100, to generatea percentage of income retained as profit after accounting for the cost of goods.
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Net profit marginor net margin isthe percentage of net income generated from a company'srevenue. Net income is often calledthe bottom line for a company or the net profit.
The net profit margin takes into account all business expenses, not merelyCOGS, and is, therefore, a more stringent metric by which to measure profitability. Net profit reflects the total revenue left over after accounting for all outgoing cash flow and additional income streams including COGS,other operational expenses,debt payments such as interest,investment income,income from secondary operations, and one-time payments for unusual events such as lawsuits and taxes.
Net profit is divided by total revenue and multiplied by 100 to yield a percentage of income that remains after all expenses.
Gross Profit Margin vs. Net Profit Margin In Practice
Let us look at these two profit margin measures using a historical example. Below is theincomestatement forApple Inc.(AAPL)as ofMarch 31,2018:
- Apple's net sales or revenue was$61 billion, and theircost of sales or cost of goods sold was$37.7 billion for the period.
- Apple's gross profit margin was 38% or (($61 billion- $37.7 billion) ÷ $61 billion)x 100.
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- As ofMarch 31, 2018,Apple'snet sales or revenue was$61 billion,and net income was $13.8B for the period.
- Apple's netprofit margin was 23% or ($13.8billion÷ $61billion) x 100.
Anet profit margin of 23% meansthat for every dollar generated by Applein sales, the company kept$0.23as profit.
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Gross profit margin (gross margin)and net profit margin (net margin) are used to determine how wella company's management is generatingprofits. It's important for investors to compare the profit margins over several periods and against companies within the same industry.
