Gross Margin vs Net Margin

Gross margin and net margin are two profitability ratios that tell you very different things about your business's financial health. Understanding both — and the gap between them — is critical for making smart decisions.

Gross margin measures how efficiently you deliver your product or service. It's calculated as (Revenue - Cost of Goods Sold) ÷ Revenue × 100. If you sell a product for $100 and it costs you $40 to make, your gross margin is 60%. This number tells you how much of every dollar in sales is available to cover your operating expenses and generate profit. High gross margins mean pricing power and efficient production. Low gross margins mean you're spending a lot to deliver what you sell.

Net margin — also called net profit margin — accounts for everything. It's calculated as Net Profit ÷ Revenue × 100. This is what's left after you pay for COGS, rent, payroll, marketing, insurance, loan interest, taxes — everything. A business with a 60% gross margin might only have a 10% net margin after all the overhead. The gap between gross and net margin reveals how heavy your operating expenses are relative to your sales. If gross margin is healthy but net margin is thin, your overhead is the problem, not your pricing or production costs.

Tracking both margins helps you diagnose problems precisely. If gross margin is declining, you have a pricing or cost-of-goods problem — maybe raw materials got more expensive or you're discounting too aggressively. If gross margin is stable but net margin is shrinking, your overhead is growing faster than your revenue — maybe you hired too fast or signed an expensive lease. Industry benchmarks matter here: a restaurant typically runs 60-65% gross margin and 3-9% net margin, while a software company might have 80%+ gross margin and 20%+ net margin. Comparing your margins to industry norms tells you whether you're competitive.