Gross Margin vs. Net Margin: What’s the Difference?

Gross margin and net margin are profitability ratios used to assess the financial well being of a company. Both gross profit margin and net margin or net profit margin are expressed in percentage terms and measure profitability as 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 profit numbers.
• Gross profit margin is computed by subtracting the cost of goods sold (COGS) from net sales, dividing by net sales, and multiplying by 100.
• Net profit margin subtracts all company expenses, including COGS, interest, and taxes, from net sales, then divides by net sales and multiplies by 100.

A Tale of Two Margins

Gross profit margin is the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). COGS are raw materials and expenses associated directly with the creation of the company’s primary product, not including any selling, general, or administrative costs.

Gross profit margin is the gross profit divided by net sales, multiplied by 100, representing the percentage of income retained as profit after accounting for the cost of goods.

Net profit margin or net margin is the percentage of net income generated from a company’s revenue. Net income is often called the bottom line for a company or the net profit.

The net profit margin takes into account all business expenses, not merely COGS, and is, therefore, a more stringent metric by which to measure profitability. Net profit reflects the 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 net sales and multiplied by 100 to yield the percentage of income remaining 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 the income statement for Apple Inc. (AAPL) as of September 28, 2024:

• Apple’s net sales or revenue was almost $94.9 billion, and their cost of sales or cost of goods sold was $51 billion for the period for the three-month period ending September 28, 2024.
• Apple’s gross profit margin was 46% or (($94.9 billion – $51 billion) ÷ $94.9 billion) x 100.

• Apple’s net sales or revenue was $94.9 billion, and net income was $14.7 billion for the three-month period ending September 28, 2024. 
• Apple’s net profit margin was 15% or ($14.7 billion ÷ $94.9 billion) x 100.

A net profit margin of 15% means that for every dollar generated by Apple in sales, the company kept $0.15 as profit.

Gross profit margin (gross margin) and net profit margin (net margin) are used to determine how well a company’s management is generating profits. It’s important for investors to compare the profit margins over several periods and against companies within the same industry.

How Can a Company Increase Profit Margin?

There are many ways a company can increase its gross and/or net profit margin. The most common methods are to increase revenue or reduce expenses. This can be accomplished in various ways, including upselling to existing customers, streamlining product offers, reducing payroll or rent, and increasing efficiency or productivity.

What Does it Mean if Gross and Net Profit Margin Are Different?

When gross and net profit margins are significantly different, this suggests that a company uses a large portion of its revenue to pay other expenses after accounting for the cost of goods sold. This may mean that a company has very low costs to produce goods and services or very high overhead costs like rent, utilities, and payroll (or, very often, both). A large difference is more common in certain industries but can also indicate inefficient cost management practices.

Which Is More Important, Gross or Net Profit Margin?

Gross and net profit margin both measure profitability, allowing investors to analyze a company’s financial health. That said, given that net profit margin considers all of a company’s expenses, it is considered a more definitive metric of profitability and, therefore, more closely scrutinized by analysts and investors.

The Bottom Line

Investors and analysts use gross profit margin and net profit margin to measure a company’s profitability and financial health. A high gross margin indicates that a company earns high profits relative to the costs to produce goods and services, while a high net margin indicates high profitability when accounting for overhead costs like administration and taxes.

Typically, net profit margin is more useful as a measure of financial health than gross profit margin, as it is the more stringent metric. When comparing profit margins, consider the industry, the age of the company, and the performance of similar businesses to ensure your analysis is as accurate as possible.