Gross Profit Margin vs. Net Profit Margin: An Overview
A profit margin is a percentage 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 margin are two separate profitability ratios used to assess a company's financial stability and overall health.
Gross profit margin is the profit remaining after subtracting the cost of goods sold (COGS) from revenue. It expresses the relationship of profit to revenue as a percentage. Net profit margin is the profit that remains after subtracting both the COGS and operating expenses from revenue.
While gross profit and gross margin are two measurements of profitability, net profit margin, which includes a company's total expenses, is a farmore 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.
Key Takeaways:
- The gross profit margin is the percentage of revenuethat exceeds the cost of goods sold.
- 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 revenuesfor a company; it reflects how much each dollar of revenue becomes profit.
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Gross profit marginis shown as a percentage while gross profit is an absolute dollar amount.
Gross Profit Margin
Gross profit margin is a measure of profitability that showsthe percentage of revenuethat 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 its products andservices. In short, the higher the number, the more efficient management is in generating profitfor every dollar of the cost involved.
The gross profit margin is calculated by takingtotal revenue minus the COGS and dividing the differenceby total revenue.The gross margin resultis typicallymultiplied by100 to show the figure as a percentage.The COGS isthe amount it costs acompany to produce the goods or services that it sells.
GrossProfitMargin=Revenue(Revenue−COGS)×100where:COGS=Costofgoodssold
Example of Gross Profit Margin
For the fiscal year endingSept. 24, 2022,Applereported total sales or revenueof $394 billion and COGS of $224billion as shown from the company's consolidated statement of operations below.
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Apple'sgross profit margin for 2022 was 43%. Using the formula above, it would be calculated as follows:
- ($394B - $224B) / $394B x 100 = 43%
This means that for every dollar Applegeneratedin sales, the company generated43 cents in grossprofit before other business expenses werepaid.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 isnot a precise measurement.
Gross Profit Margin vs.Gross Profit
It is important to note thedifference between gross profit margin andgross profit. Gross profit marginis 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 statementabove, Apple's gross profit figurewas$170 billion (or $394 billionminus $224 billion).
In short, gross profitis the total amount of gross profit aftersubtracting revenue fromCOGS—or$170 billion in the case of Apple. But the gross margin is the percentageof profit Apple generatedper thecost of producing its goods, or 43%.
The gross profit figure is of little analytical valuebecause 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) ismore significant for marketanalystsand 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 to make the company lose money.
Net Profit Margin
The net profit margin is the ratio of net profits torevenuesfor a company or business segment. Expressed as a percentage, the net profitmarginshows how much of each dollar collected by a company as revenue translates to profit.
Net profitability is an important distinctionsince 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 asnet income.
NetProfitMargin=Revenue(NI)×100where:NI=Netincome=R−COGS−OE−O−I−TR=RevenueOE=OperatingexpensesO=OtherexpensesI=InterestT=Taxes
Example of NetProfit Margin
Apple reported a net income number of roughly $100 billion for the fiscal year ending Sept. 24, 2022, as shown from its consolidated statement of operations below.As we saw earlier, Apple'stotal sales or revenue was$394 billion for the same period.
Apple's netprofit margin for 2022 was 21%. Using the formula above, we can calculate it as:
- $100B / $394B = 0.25
- 0.25 x 100 = 25%
A 25% net profit margin indicates that for every dollar generated by Applein sales, the company kept$0.25as 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 marginswith 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 hasa 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 laborand raw materials, recessionary periods, and the introduction of disruptive technological tools that could affect the company's bottom line.
What's the Difference Between Gross Profit and Gross Margin?
Gross profit is the dollar amount of profits left over after subtracting the cost of goods sold from revenues. Gross margin shows the relationship of gross profit to revenue as a percentage.
What Is the Difference Between Net Profit and Margin?
Net profit is the dollar figure that shows the profit that remains after subtracting the cost of goods sold, operating expenses, taxes, and interest on debt. Margin is a percentage that shows profit compared to revenue.
Which Is Better: Gross Profit Margin or Net Profit Margin?
While gross profit margin and net profit margin each show valuable information, net profit margin is often the more useful metric, as it accounts for not only the cost of goods sold but also other operating expenses, which can affect overall profitability.
The Bottom Line
Investors and analysts typically use both gross profit margin andnet profit margin to gauge how efficient a company's management is inearning profits relative to the costs involved in producing their goods and services.
Net profit margin gives a more comprehensive picture of a company's overall profitability as it also includes operating expenses, whereas gross profit margin does not. It is wise to compare the margins of companies within the same industry and over multiple periods to get a sense of anytrends.
