A Quick Brief on Gross Profit Margin and Net Profit Margin

Gross Profit Margin and Net Profit Margin are two different profitability ratios which are used to assess a firm’s stability and financial profitability. Profit margin is a ratio expressed commonly in percentage which shows the profit of a company per rupee of sales i.e. profit per rupee of sales. A company will have higher profit margin if it makes more profit on sales. In order to understand the difference between the two, we have listed a few pointers and examples in the below-given post.

What is a Gross Profit Margin?

It shows ratio of gross profit to sales. Gross profit is calculated after subtracting cost of goods sold from total sales. Cost of goods sold is actually the cost of the goods that the company incurs to produce them for sale purpose. It is abbreviated as COGS. The gross profit margin is just an indication of profitability of a firm and not a precise reflection of great financial health. It is crucial in analyzing a company’s prospects to attain funds for working capital or other business needs.

Formula for Gross profit margin = (revenue – COGS)/ revenue

For example, if a company has a total sales of Rs 10 Lakh crores and for those sales, the cost it incurs to produce goods comes 6 Lakh crores, then the gross profit margin comes to be (10-6)/10 i.e. 40%. Remember that gross profit and gross profit margin are distinct. The latter is depicted as a percentage, and the former in an absolute currency amount.

What is a Net Profit Margin?

The net profit margin is a more precise and accurate method of coming to the profitability of the firm as it reveals the exact portion of the revenue that constitutes the company’s profit per unit or per rupee sales. An increase in revenue may not necessarily mean increase in profitability but net profitability is precise in this regard. Net profit is gross profit less operating expenses, other expenses, interest and taxes. Hence from above formula it is quite clear that the net profit and net profit margin give a clearer picture of financial soundness and profitability of a company when it is compared to sales.

Formula for Net profit margin = (revenue - COGS – operating expenses – other expenses – interest – taxes)/ revenue

It is possible for a company to have a negative net profit margin, which occurs when the business encounters a loss for the quarter or the year. However, such a loss could be a temporary issue to the company. Losses can increase in recessionary periods, use of new technological tools that impact production, increase in the cost of raw material or cost of labor, etc.

To Conclude:

Analytics and investors use both these calculations to judge a business management and the profit it earns relative to the included costs in production of goods and services. The net margin and gross margin are critical to a company’s financial health. Thus, both must be watched closely at timely intervals. A drop in any of these measurements must be studied in detail and rectifications steps must be taken to restore their stability.

I am freelance content writer & financial advisor @ Loanbaba.com