Though those in finance, economics, accounting and investing may consider the intricacies of business finance to be all in a day's work, many of the calculations they handle regularly may seem daunting to the amateur investor or fledgling entrepreneur. Two concepts often misunderstood or misused by the general public are gross margin and net margin. Both are metrics that reflect the percentage of total business revenue retained as profits after certain expenses, but they differ in key ways.
The gross profit margin utilizes two figures easily found on any profit and loss statement or balance sheet: revenue and gross profit. Revenue is the top line of a P&L statement and reflects the total income from the sale of goods or services. Gross profit means revenue less the cost of goods sold, or COGS. These 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. The gross profit margin is simply the gross profit divided by total revenue. This figure is multiplied by 100 to yield a percentage of income retained as profit after accounting for the cost of goods.
The net profit margin takes into account all business expenses, not simply COGS, and is therefore a more stringent metric by which to measure profitability. Net profit is the infamous bottom line of a P&L statement and 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.