Gross profit margin and net profit margin are two important financial metrics that can asses how profitable your company is.
While they both focus on profitability, these two are different in how they assess your company’s operations. People often get confused between the two, and their use cases.
We are here to help you break down these differences along with relevant examples. Here we go.
Contents
What is profit?
In simple terms, profit is the money earned by an entrepreneur from running their business after all expenses (costs of materials, eCommerce website, salaries, electricity, etc.) have been paid.
Profit is the income that remains after the total revenue from a business is subtracted from all the costs associated with running that business.
What is the profit margin?
Profit margin is calculated as a percentage by dividing the profit by total revenue. Profit margin helps you understand the difference between different goods that you are selling and how profitable it is.
For example, if we say that selling biscuits online has a profit margin of 35% and selling watches online has a profit margin of 70%. You would understand that selling watches will have a higher income compared to the costs involved.
Related read: Top 15 high profit margin products to sell online in India (2023)
What is Gross Profit Margin?
Gross profit margin measures how profitable a company is by assessing the difference in revenue generated from sales and the direct costs associated with producing or providing the goods or services sold.
The formula for calculating gross profit margin is as follows:
Gross Profit Margin = (Gross Profit / Revenue) x 100
Where: Gross Profit = Revenue – Cost of Goods Sold (COGS)
Gross profit is what’s left from revenue after subtracting the costs directly tied to producing the goods or services sold.
COGS usually includes expenses like raw materials, labour involved in production, and manufacturing overhead.
What is Net Profit Margin?
Net profit margin gives you a broader sense of your company operations. If gross margin takes into consideration direct costs involved when selling, Net margin takes direct as well as indirect expenses into consideration like operating expenses, taxes, interest, etc.
Net profit margin evaluates the overall profitability of a company, taking into account all expenses, including both direct costs (COGS) and indirect expenses
The formula for calculating net profit margin is as follows:
Net Profit Margin = (Net Profit / Revenue) x 100
Where: Net Profit = Revenue – Total Expenses
Net profit is what’s left in the bank after subtracting all the expenses from the revenue. These expenses cover everything from COGS to operating expenses, interest, taxes, and any other costs the company bears.
Important business expenses to consider
To help our understanding of the difference between gross profit margin and net profit margin, let’s dive a little deeper into direct and indirect expenses.
Let’s take the example of operations run by an online jewellery business. The list of expenses is as follows:
Cost of Goods Sold (COGS)
As mentioned before, COGS covers all the direct costs linked to making or delivering the goods or services sold by a company.
It includes expenses like raw materials, labour costs directly related to production, and manufacturing overhead.
For an online jewellery business, the COGS includes the direct costs associated with producing or purchasing the jewellery items they sell.
These costs could include:
a. Wholesale or manufacturing costs: If the business designs and manufactures its jewellery, it will include the cost of raw materials (e.g., metals, gemstones) and production labour.
b. Purchase costs: If the business sources jewellery from suppliers, the cost of purchasing finished pieces from wholesalers or manufacturers will be part of the COGS.
Operating Expenses (OPEX)
Operating expenses are indirect expenses incurred to run the day-to-day operations of a business. They are not directly tied to the production of goods or services but are essential to keep the business functioning.
Operating expenses can include:
1. Selling expenses
These include expenses related to sales and marketing efforts, such as advertising, sales commissions, sales salaries, and promotional expenses.
2. General and administrative expenses (G&A)
These expenses cover the administrative and management functions of the company, including salaries of non-production employees, office rent, utilities, insurance, and other administrative costs.
3. Research and Development (R&D)
For companies engaged in developing new products or technologies, R&D expenses are deducted. These costs help improve existing products or develop new ones.
The operating costs of an online jewellery business will also include:
a. Website costs: This includes expenses for website development, hosting, maintenance, and online payment processing. Unless you start with Instamojo where you can host your jewellery online store for FREE.
b. Marketing and advertising: Expenses for digital marketing campaigns, social media promotions, and influencer collaborations to attract customers to the online store.
c. Packaging and shipping: Costs associated with jewellery packaging materials, shipping fees, and logistics.
Related read: eCommerce shipping for small businesses: the complete guide
d. Customer service: Salaries or outsourcing costs for customer service representatives to handle inquiries, complaints, and returns.
e. Rent and utilities: If the business operates from a physical location, like a small workshop or office, operating expenses will include rent and utility costs.
f. Business Insurance: Insurance premiums to protect the business against potential risks, such as theft or damage to inventory.
g. Payment Processing Fees: Charges imposed by payment gateways or credit card companies for processing online transactions.
Instamojo charges only a 2% + ₹3 transaction fee for using their payment gateway.
Interest expenses
Interest expenses refer to the cost of borrowing money or servicing debt.
So, if a company has taken loans or issued bonds, it has to pay interest on that borrowed amount. Deduct these interest expenses from revenue to calculate the net profit.
Taxes
Income taxes are levied on a company’s profits by the government. The company must deduct the applicable income taxes from its revenue to calculate the net profit.
Other Non-Operating Expenses
Other non-operating expenses may include one-time expenses, restructuring costs, legal settlements, or other expenses that are not directly related to the company’s core business operations.
Related read: Keep your Business Compliant with LegalWiz Apps On mojoDeveloper Program
Key Differences between net profit margin and gross profit margin
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