Difference Between Gross Profit Margin and Net Profit Margin

As an investor, it is imperative to invest in companies that are profitable in order to earn capital gains and dividends. A company’s profitability can be assessed by investors using profitability ratios such as the gross profit margin and the net profit margin. This article explains the difference between the two and the importance of understanding them in order to make informed investment decisions.

What is gross profit margin? 

Gross profit margin is a profitability measure that signifies the gross profit a company earns against every single rupee of its total revenue. Also known as the gross margin it shows the percentage of total revenue that a company earns as gross profit.

The gross profit margin reflects the efficiency of a company in generating revenue taking into consideration the production costs. Hence, a higher gross profit margin number means that the company is generating more profit for every rupee of cost incurred.

For example, if the gross profit margin of a company is 65%, it is earning Rs 0.65 gross profit against Re 1 of its total revenue.

What is net profit margin?

Net profit margin, also known as the net margin, is the percentage of the total revenue that a company reports as net profit. The net profit is the total profit of the company after deducting its indirect cost i.e., interests, taxes, and operating costs from its gross profit.

It is to be noted that the gross profit is calculated after deducting the cost of goods sold (COGS) from total revenue. Meanwhile, while calculating net profit, all expenses and taxes are deducted from the total revenue. This will make the gross profit margin of a company always higher than its net profit margin.

How are gross profit margin and net profit margin calculated?

One of the key difference between gross margin and net margin is its formula of calculation. Read on to learn how gross and net profit margins can be calculated.

To calculate gross profit margin, you must first calculate gross profit. You can calculate the gross profit by deducting the following expenses the total revenue:

• Raw materials cost
• Labour cost
• Production cost
• Cost incurred for inventory maintenance

Once you have calculated the gross profit, use the following formula to calculate gross profit margin:

Gross profit margin = (Gross profit / Total revenue) x 100

Calculating net profit margin becomes very easy on knowing gross profit. Similar to gross profit margin you must first calculate net profit. You can calculate the net profit by deducting the following items from the gross profit.

• Cost of revenue
• Depreciation cost
• Administration overheads
• Interest payments on debts
• Taxes

On obtaining the net profit, use the following formula to calculate the net profit margin:

Net profit margin = (Net profit/ Total revenue) x 100

Here’s an example to understand the gross and net profit margin calculations better:

Below mentioned is the income statement of ‘Company A’ for the financial year 2021-22.

Substitute the values respectively in the gross profit and net profit margin formula:

• Gross profit margin = (Gross profit / Total revenue) x 100

        Gross profit margin = (7,60,000/ 10,00,000) x 100 = 76%

• Net profit margin = (Net profit/ Total revenue) x 100

      Net profit margin = (2,60,000 / 10,00,000) x 100 = 26%

How to interpret gross profit margin and net profit margin?

Both gross profit margin and net profit margins are widely used profitability ratios. They help you understand the company’s profitability and cost management efficiency. This in turn helps you grasp details about the company’s financial health. Knowing this information, you are able to make suitable investment decisions. Investors can make use of both margins to compare the financial health and operational efficiencies of different companies.

What is the difference between gross profit margin and net profit margin?

Refer to the following difference table to get a clear view of the Gross margin vs Net margin comparison:

Bottom line

Gross profit margin and net profit margin are the most popular profitability ratios. Both ratios reveal great details about the company’s financial health primarily its cost management efficiency and profitability. Employ these profitability ratios to find the right stock company and make a suitable investment.

ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. I-Sec is a Member of National Stock Exchange of India Ltd (Member Code :07730), BSE Ltd (Member Code :103) and Member of Multi Commodity Exchange of India Ltd. (Member Code: 56250) and having SEBI registration no. INZ000183631. Name of the Compliance officer (broking): Ms. Mamta Shetty, Contact number: 022-40701022, E-mail address: complianceofficer@icicisecurities.com. Investments in securities markets are subject to market risks, read all the related documents carefully before investing. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.