Understanding Two Margins

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.

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 overhead costs such as rent, utilities, freight, or payroll. Gross profit margin is the gross profit divided by total revenue, multiplied by 100, to generate a 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 total 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 total revenue and multiplied by 100 to yield a percentage of income that remains after all expenses.

Gross Profit Margin and Net Profit Margin

Below is the income statement for Apple Inc. (AAPL) as of March 31, 2018:

  • Apple's net sales or revenue was $61B, and their cost of sales or cost of goods sold was $37.7B for the period.
  • Apple's gross profit margin was 38% or (($61B - $37.7B) ÷ $61B) x 100.
  • As of March 31, 2018, Apple's net sales or revenue was $61B, and net income was $13.8B for the period.  
  • Apple's net profit margin was 23% or ($13.8 billion ÷ $61 billion) x 100.

A net profit margin of 23% means that for every dollar generated by Apple in sales, the company kept $0.23 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. For more on profit margins, please read "What Is Considered a Healthy Operating Profit Margin?"