When to use gross margin vs. gross profit

Gross margin and gross profit measure a company’s profitability. However, they do this in different ways. Gross profit is used to assess overall profitability and is a fixed dollar amount, while gross margin is a ratio or a percentage and compares profitability across periods or between companies. 

Both metrics help provide an “at-a-glance” look at a company’s overall efficiency and profitability. Therefore, understanding how to calculate and interpret these metrics can help you maintain the health and longevity of your business. Keep reading to learn more.

What you’ll learn:

• Both gross margin and gross profit can help business owners understand their company’s profitability, but there are some differences between the two metrics.
• Gross margin is typically a percentage and provides insights into your company’s health over a specific period.
• Gross profit is generally a concrete dollar amount and reflects how your company handles production costs.
• Attaining high gross margins and gross profits signifies the health and stability of your company. 

Gross margin is important because it reflects a company’s sustainability by measuring its revenue after accounting for the cost of goods sold (COGS). For example, if your company’s gross margin is 25%, then 25% of its revenue remains after covering the costs of producing goods or services.

To calculate your company’s gross margin, you’ll need the following information:

• Net sales: The total revenue your business generated from sales over a specific period.
• COGS: This includes those costs associated with producing goods or services like labor, materials, etc.
• Gross profit: Calculated by subtracting the COGS from the net sales.

With this information, apply the following calculation:

For example, a manufacturing company realizes the following over 12 months:

• Net sales = $550,000
• COGS = $150,000
• Gross profit = $400,000

This company’s gross margin is almost 73% during that time period.

Gross profit—also known as gross income or sales profit—measures a company’s profit from its core operations before subtracting expenses like cost of operation, interest charges and taxes. It’s the difference between revenue from sales and COGS. 

Gross profit is an important metric because it offers insight into how efficiently a company manages production costs relative to its revenue.

To calculate gross profit, you’ll need the following information:

• Total revenue: This is the total amount of money generated from all business activities, including sales of goods and services, interest and investment income. It’s the gross amount before any deductions.
• COGS (for a given period)

With this information, apply the following calculation: Gross profit = Revenue – COGS.

For example, that same manufacturing company’s gross profit over 12 months would look like this:

• Total revenue = $750,000
• COGS = $150,000

Gross profit = 750,000 – 150,000. This company’s gross profit is $600,000 over that 12-month period. 

Typically, businesses use gross margin to assess profitability and efficiency over time and gross profit to measure total earnings after production costs.

When thinking about the two, it may be easier to consider them this way: Do you need insights into your company’s health at a particular moment (gross margin), or are you looking for how much revenue your business generates before expenses (gross profit)?

A higher gross margin typically indicates enhanced cost management and the potential for increased profits, while a lower gross margin may signal the need to adjust prices or reduce expenses.

Similarly, higher gross profits indicate efficient production processes and effective pricing strategies. And lower gross profits suggest that a large portion of revenue is spent on COGS, which leaves less money for other expenses and operating costs.

Gross margin and gross profit are important financial metrics. Here are some more frequently asked questions business owners have about them:

Gross profit, typically a dollar amount, indicates a company’s revenue after production costs. Gross margin, generally a percentage, compares profitability over time or across companies. These metrics can provide a comprehensive view of a company’s financial health and operational effectiveness when considered together.

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