Gross Margin vs Net Margin: Why the Difference Matters
Financial terminology can sometimes feel overwhelming, but understanding a few key concepts can dramatically improve your business strategy.
Two of the most important? Gross margin and net margin.
Although they sound similar, they tell very different stories about your business. Let’s dive into the differences, calculations, and why both matter.
What is Gross Margin?
Gross margin measures how efficiently you produce or deliver your goods and services after covering only direct costs (also called Cost of Goods Sold or COGS).
Gross Margin Formula:
(Revenue - COGS) ÷ Revenue × 100
Example:
- Revenue = £100,000
- COGS = £60,000
- Gross Margin = 40%
You keep 40% of revenue after production costs.
What is Net Margin?
Net margin (also called net profit margin) measures how much of your total revenue remains after all expenses have been deducted — not just production costs.
Expenses included:
- Salaries
- Rent
- Utilities
- Taxes
- Loan repayments
- Marketing costs
Net Margin Formula:
(Net Profit ÷ Revenue) × 100
Example:
- Revenue = £100,000
- Total Expenses = £95,000
- Net Profit = £5,000
- Net Margin = 5%
You keep 5 pence of every pound earned after covering all costs.
Key Differences at a Glance
Here’s a quick comparison of gross margin vs net margin:
Why Both Margins Matter
- Gross Margin: Helps you price products correctly and control direct costs.
- Net Margin: Shows if your overall business model is profitable after all expenses.
Tip: A business can have a strong gross margin but a weak net margin if overhead costs are too high.
What Are Good Gross and Net Margins?
Typical margins vary by industry:
- SaaS companies: Gross Margin 70–90%; Net Margin 10–30%
- Retail businesses: Gross Margin 20–50%; Net Margin 2–8%
- Manufacturing: Gross Margin 25–40%; Net Margin 5–15%
Always benchmark against industry peers.
Common Mistakes to Avoid
- Relying solely on gross margin to assess profitability.
- Confusing high sales volume with strong net profits.
- Ignoring rising overhead costs impacting net margins.
Final Thoughts
Both gross margin and net margin are crucial to understanding your financial health.
Master both, and you'll be better equipped to:
- Price smarter
- Control operational costs
- Build a truly profitable business
Deepen your financial understanding with these related guides:
- Understanding Gross Margin — Build a strong foundation by mastering gross margin concepts.
- How to Calculate Gross Profit: Formulas, Examples and Insights — Learn how to calculate your gross profit accurately and apply it in financial planning.
- Why Gross Margin is the Health Check Your Business Can't Ignore — Discover why gross margin — along with net margin — is vital for tracking business health.
