What Is the Difference Between Gross Profit Margin and Net Profit Margin?
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. Gross profit margin and net profit marginon the other hand, are two separate profitability ratios used to assess a company’s financial stability and overall health.
- The gross profit margin is the percentage of revenue that exceeds the COGS.
- A high gross profit margin indicates that a company is successfully producing profit over and above its costs.
- The net profit margin is the ratio of net profits to revenues for a company; it reflects how much each dollar of revenue becomes profit.
Understanding Gross Profit Margin and Net Profit Margin
While gross profit and gross margin are two measurements of profitability, net profit margin, which includes a company’s total expenses, is a far more definitive profitability metric, and the one most closely scrutinized by analysts and investors. Here’s a more in-depth look at gross profit margin and net profit margin.
Gross Profit Margin
Gross profit margin is a measure of profitability that shows the percentage of revenue that exceeds the cost of goods sold (COGS). The gross profit margin reflects how successful a company’s executive management team is in generating revenue, considering the costs involved in producing their products and services. In short, the higher the number, the more efficient management is in generating profit for every dollar of cost involved.
The gross profit margin is calculated by taking total revenue minus the COGS and dividing the difference by total revenue. The gross margin result is typically multiplied by 100 to show the figure as a percentage. The COGS is the amount it costs a company to produce the goods or services that it sells.
Gross Profit Margin=Revenue(Revenue−COGS)×100where:
Explaining Gross Vs. Net Profit Margin
Example of Gross Profit Margin
For the fiscal year ending September 30, 2017, Apple reported total sales or revenue of $229 billion and COGS of $141 billion as shown from the company’s consolidated 10K statement below.
Apple’s gross profit margin for 2017 was 38%. Using the formula above, it would be calculated as follows:
This means that for every dollar Apple generated in sales, the company generated 38 cents in gross profit before other business expenses were paid. A higher ratio is usually preferred, as this would indicate that the company is selling inventory for a higher profit. Gross profit margin provides a general indication of a company’s profitability, but it is not a precise measurement.
Gross profit margin is shown as a percentage while gross profit is an absolute dollar amount.
Gross Profit Margin vs. Gross Profit
It is important to note the difference between gross profit margin and gross profit. Gross profit margin is shown as a percentage while gross profit is an absolute dollar amount.
The gross profit is the absolute dollar amount of revenue that a company generates beyond its direct production costs. Thus, an alternate rendering of the gross margin equation becomes gross profit divided by total revenues. As shown in the statement above, Apple’s gross profit figure was $88 billion (or $229 billion minus $141 billion).
In short, gross profit is the total number of gross profit after subtracting revenue from COGS—or $88 billion in the case of Apple. But the gross margin is the percent of profit Apple generated per the cost of producing its goods, or 38%.
The gross profit figure is of little analytical value because it is a number in isolation rather than a figure calculated in relation to both costs and revenue. Therefore, the gross profit margin (or gross margin) is more significant for market analysts and investors.
To illustrate the difference, consider a company showing a gross profit of $1 million. At first glance, the profit figure may appear impressive, but if the gross margin for the company is only 1%, then a mere 2% increase in production costs is sufficient enough to make the company lose money.
Net Profit Margin
The net profit margin is the ratio of net profits to revenues for a company or business segment. Expressed as a percentage, the net profit margin shows how much of each dollar collected by a company as revenue translates to profit.
Net profitability is an important distinction since increases in revenue do not necessarily translate into increased profitability. Net profit is the gross profit (revenue minus COGS) minus operating expenses and all other expenses, such as taxes and interest paid on debt. Although it may appear more complicated, net profit is calculated for us and provided on the income statement as net income.
Net Profit Margin=Revenue(NI)×100where:IN=Net incomeR=RevenueOE=Operating expensesO=Other expensesI=Interest
Example of Net Profit Margin
Apple reported a net income number of roughly $48 billion (highlighted in blue) for the fiscal year ending September 30, 2017, as shown from its consolidated 10K statement below. As we saw earlier, Apple’s total sales or revenue was $229 billion for the same period.
Apple’s net profit margin for 2017 was 21%. Using the formula above, we can calculate it as:
A 21% net profit margin indicates that for every dollar generated by Apple in sales, the company kept $0.21 as profit. A higher profit margin is always desirable since it means the company generates more profits from its sales.
However, profit margins can vary by industry. Growth companies might have a higher profit margin than retail companies, but retailers make up for their lower profit margins with higher sales volumes.
It is possible for a company to have a negative net profit margin. A negative net profit margin occurs when a company has a loss for the quarter or year. That loss, however, may just be a temporary issue for the company. Reasons for losses could be increases in the cost of labor and raw materials, recessionary periodsand the introduction of disruptive technological tools that could affect the company’s bottom line.
Investors and analysts typically use both gross profit margin and net profit margin to gauge how efficient a company’s management is in earning profits relative to the costs involved in producing their goods and services. It is wise to compare the margins of companies within the same industry and over multiple periods to get a sense of any trends.