Lessons · Accounting · gross margin and net margin
Gross margin and net margin
A margin is profit as a share of sales. Gross margin is gross profit divided by sales; net margin is net profit divided by sales.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
What it is for
March sold 40,000 and April sold 65,000, and the owner wants to know which month the business ran better. Profit in money cannot say, because April was bigger. Profit as a share of sales can.
How to think about it
Take the profit line you care about, divide by sales, and read it as a percentage. Always sales underneath, never cost; dividing by cost gives a different number with a different name.
Worked example
Sales 80,000, cost of goods sold 48,000 → gross profit 32,000From the income statement.
Gross margin = 32,000 / 80,000 = 0.40 = 40%Forty cents of every sales dollar is left after paying for the goods.
Net profit 5,000 → Net margin = 5,000 / 80,000 = 0.0625 = 6.25%Just over six cents of every dollar reaches the bottom line.
Your turn
Gross profit 27,000 and a gross margin of 30%. Write the line with the sales filled in.
Gross margin = 27,000 / = 30%
Solve one, graded on the server
The trap
Dividing by cost instead of sales. 32,000 / 48,000 is 67%, which is the markup, and quoting it as a margin makes the business sound far healthier than it is.