Here’s Everything You Need To Know About Gross Margin

What Is Gross Margin?

Gross margin, often referred to as gross profit margin, is a key financial metric used to evaluate a company’s profitability and operational efficiency. It’s calculated by deducting the total cost of goods sold (COGS) from the company’s total revenue and then expressing the resulting figure as a percentage of revenue.

Essentially, it shows the amount of money a company retains from its revenue after deducting direct costs associated with producing or delivering products or services. It is shown as a percentage of total revenue.

A higher gross margin percentage indicates that a company is effectively managing its production costs, which is a positive sign for investors and stakeholders. Conversely, a lower gross margin suggests that a company may be struggling to control its production expenses. Gross margin analysis is particularly useful for assessing the core profitability of a business before factoring in other operating costs and overhead expenses.

How To Calculate Gross Margin?

The following is the formula to calculate the gross margin: 

Gross Margin (%) = (Total Revenue – Cost of Goods Sold) / Total Revenue) * 100

What Is Gross Profit?

Gross profit is the money a company makes from selling its products or services minus the costs directly related to making or buying those products or services. It’s like calculating how much money you get from selling lemonade minus the cost of lemons, sugar, and cups.

This number shows how well a company is doing at making money from its main business activities, without considering other expenses like advertising or rent. It’s a useful metric to see how efficient a company is at making a profit from its core operations.

How To Calculate Gross Profit?

Gross Profit = Total Revenue – Cost of Goods Sold

What Is Gross Margin Ratio?

Gross margin ratio shows a company’s gross profit as a percentage of its total revenue. This ratio provides an understanding of how efficiently a company is managing its production costs.

How To Calculate Gross Margin Ratio?

The following is the formula to calculate gross margin ratio:

Gross Margin Ratio = Gross Profit / Total Revenue

What Is Net Profit?

Net profit goes beyond gross profit by considering all expenses, including taxes, interest, and depreciation and amortisation. It gives a complete view of the overall profit after accounting for all expenditures.

If a brand earns INR 1,000 from selling a bag and spends INR 300 to make the bag, the gross profit would be INR 700 (INR 1,000 – INR 300). However, if advertising, marketing, taxes, interest, depreciation and amortisation amount to an additional INR 200, the net profit would be INR 500 (INR 700 – INR 200).

Net profit shows the profit a company truly retains after factoring in all costs.

What Is Net Margin?

Net margin, or net profit margin, shows the amount of net profit a company generates as a percentage of its revenue.

Net Margin (%) = (Net Profit/ Total Revenue)*100

What Is The Difference Between Gross Margin and  Net Margin?

The following are the key differences between gross margin and net margin when describing a company’s financial performance.

• Gross Margin:
  • Focus: Gross margin primarily focuses on a company’s core operations and production efficiency. It reveals how effectively a company is managing its production costs.
  • Interpretation: A higher gross margin percentage indicates that a company is earning more profit from its core business activities before considering other expenses like marketing, administration, and taxes.
• Net Margin:
  • Focus: Net margin provides a more comprehensive view of a company’s overall profitability, as it takes into account all operating expenses, taxes, and interest.

Interpretation: A higher net margin percentage suggests that a company is efficient in its core operations (as indicated by a high gross margin) and effective in managing all its expenses, interest payments, and taxes. It reflects the bottom line profitability after all costs are considered.