Gross Margin
Gross margin (also known as the gross profit margin) is a financial metric that gives a general overview of the profitability as well as efficiency of a business. It is important to understand that the gross profit margin helps the management and other stakeholders analyse the business performance over a long period of time. These margins can be looked at on a yearly basis and also compared with the competitors to see if your business is performing well or not. If the gross profit margin is inconsistent or is decreasing at different calculation intervals, then the company and its management must begin to examine the reasons for it and fix it before it becomes a major problem. The formula for calculating the gross margin is given below:
Gross Profit margin = [(Total Revenue – Cost of Goods Sold) / Total Revenue] * 100
Net Margin
Net margin (also known as the net profit margin) is a financial measure that helps to evaluate the net income or profit that is generated from the overall revenue. It is defined as the total percentage of the overall revenue that is turned into a profit after taking into account all the expenses. Like the gross margin, the net margin should also be compared on a yearly basis to see if there is a huge fluctuation and analyse the reason for those inconsistencies. It must also be compared with the competitors to understand the actual position of your company in the industry and how to improve your position further. The formula for calculating the net margin is given below:
Net Profit margin = (Net Income/ Total Revenue) * 100
Difference between gross and net margin
Both gross and net margins are useful to understand the financial position of a company. The management and stakeholders give importance to these figures and carry out a detailed analysis of what it indicates for the company’s future. However, there are several points of difference between gross and net margin, and we will try to throw some light on these variances:
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Gross margin is the total percentage of gross income that is generated from the company’s revenue. |
Net margin is the total percentage of net income that is generated from the company’s revenue. |
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The gross margin is larger in scope than the net margin because it does not account for administrative and selling expenses. |
The net margin is smaller in scope than the gross margin because it accounts for administrative and selling expenses. |
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The gross margin does not include the effect of income taxes. |
The net margin includes the effect of income taxes. |
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The gross margin incorporates a higher percentage of variable expenses. |
The net margin incorporates a lower percentage of variable expenses. |
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The formula for calculating the gross margin is given below: Gross Profit margin = [(Total Revenue – Cost of Goods Sold) / Total Revenue] * 100 |
The formula for calculating the net margin is given below: Net Profit margin = (Net Income/ Total Revenue) * 100 |
Conclusion
Both gross and net margins are profitability ratios that help to get a better picture of the financial viability of any organisation. So it is important that the management try to understand the key details related to these margins and use them to improve the financial standing of their firm in the long run.
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