Gross, Operating, and Net Profit Margin: An Overview
Gross profit margin, operating profit margin, and net profit margin are the three main margin analysis measures that are used to analyze the income statement activities of a firm.
Each margin individually gives a very different perspective on the company’s operational efficiency. Comprehensively the three margins taken together can provide insight into a firm’s operational strengths and weaknesses (SWOT). Margins are also useful in making competitor comparisons and identifying growth and loss trends against past periods.
Key Takeaways
- An income statement is divided by direct, indirect, and interest and tax expenses.
- Gross profit, operating profit, and net profit margins are important measures for analyzing an income statement.
- Each profit margin measure shows the amount of profit per dollar of a company’s revenue.
Overall, margin analysis metrics measure the efficiency of a firm by comparing profits against costs at three different spots on an income statement.
Gross Profit Margin
Gross profit margin analyzes the relationship between gross sales revenue and the direct costs of sales. This comparisonforms the first section of the income statement. Companies will have varying types of direct costs depending on their business. Companies that are involved in the production and manufacturing of goods will use the cost of goods sold measure while service companies may have a more generalized notation.
Overall, the gross profit margin seeks to identify how efficiently a company is producing its product. The calculation for gross profit margin is gross profit divided by total revenue. In general, it is better to have a higher gross profit margin number as it represents the total gross profit per dollar of revenue.
Operating Profit Margin
Operating efficiency forms the second section of a company’s income statement and focuses on indirect costs. Companies have a wide range of indirect costs which also influence the bottom line. Some commonly reported indirect costs includes research and development, marketing campaign expenses, general and administrative expenses, and depreciation and amortization.
Operating profit margin examines the effects of these costs. Operating profit is obtained by subtracting operating expenses from gross profit. The operating profit margin is then calculated by dividing the operating profit by total revenue.
Operating profit shows a company’s ability to manage its indirect costs. Therefore, this section of the income statement shows how a company is investing in areas it expects will help to improve its brand and business growth through several channels. A company may have a high gross profit margin but a relatively low operating profit margin if its indirect expenses for things like marketing, or capital investment allocations are high.
Net Profit Margin
Net profit margin is the third and final profit margin metric used in income statement analysis. It is calculated by analyzing the last section of the income statement and the net earnings of a company after accounting for all expenses.
Net profit margin takes into consideration the interest and taxes paid by a company. Net profit is calculated by subtracting interest and taxes from operating profit—also known as earnings before interest and taxes (EBIT). The net profit margin is then calculated by dividing net profit over total revenue.
Net profit spotlights a company’s ability to manage its interest payments and tax payments. Interest payments can take several varieties. Interest includes the interest a company pays stakeholders on debt for capital instruments. It also includes any interest earned from short-term and long-term investments.
Taxes are charged at a flat rate for corporations. Following the 2017 Tax Cuts and Jobs Act, the corporate tax rate was reduced from 35% to 21%. Just like individuals, corporations must also identify and account for corporate tax breaks that come in the form of credits, deductions, exemptions, and more.
Special Considerations
The net profit margin of a company shows how the company is managing all the expenses associated with the business. On the income statement, expenses are typically broken out by direct, indirect, and interest and taxes. Companies seek to manage expenses in each of these three areas individually.
By analyzing how the gross, operating, and net profit margins compare to each other, industry analysts can get a clear picture of a company’s operating strengths and weaknesses.
Market and business factors may affect each of the three margins differently. Systematically if direct sales expenses increase across the market, then a company will have a lower gross profit margin that reflects higher costs of sales.
Companies may go through different cycles of growth that lead to higher operational, and interest expenses. A company may be investing more in marketing campaigns or capital investments that increase operating costs for a period which can decrease operating profit margin. Companies may also raise capital through debt which can decrease their net profit margin when interest payments rise.
Understanding these different variables and their effects on margin analysis can be important for investors when analyzing the worthiness of corporate investment.
FAQs
The three main profit margin metrics are gross profit margin (total revenue minus cost of goods sold (COGS) ), operating profit margin (revenue minus COGS and operating expenses), and net profit margin (revenue minus all expenses, including interest and taxes).
What is the difference between gross profit operating profit and net profit? ›
Gross profit is the amount a business has earned minus the direct costs of manufacturing or the cost of goods sold. Operating profit is the amount of the gross profit minus operational costs. Net profit is the total amount left over after the business has accounted for all deductions, including interest and taxes.
Is net profit margin the same as gross profit margin? ›
Gross profit margin is the profit remaining after subtracting the cost of goods sold (COGS) from revenue. It expresses the relationship of profit to revenue as a percentage. Net profit margin is the profit that remains after subtracting both the COGS and operating expenses from revenue.
Are operating and profit margin the same? ›
The difference between them is that gross profit margin only figures in the direct costs involved in production, while operating profit margin includes operating expenses like overhead. Both metrics are important in assessing the financial health of a company.
Is operating profit the same as net profit? ›
Operating profit is the money left after paying all business costs, but before paying tax. An operating profit shows that your business can generate more money than it spends. However you still have taxes to pay before getting to net profit (which is the money you get to keep).
What are gross operating and net profit margins? ›
The three main profit margin metrics are gross profit margin (total revenue minus cost of goods sold (COGS) ), operating profit margin (revenue minus COGS and operating expenses), and net profit margin (revenue minus all expenses, including interest and taxes).
What does gross profit margin tell you? ›
The gross profit margin tells you what your business made after paying for the direct cost of doing business, which can include labour, materials and other direct production costs. It's one of three major profitability ratios, the others being operating profit margin and net profit margin.
What is a good net profit margin? ›
As a rule of thumb, 5% is a low margin, 10% is a healthy margin, and 20% is a high margin.
What is a healthy gross margin? ›
What is a Good Gross Profit Margin?
| Industry | Gross Profit Margin | Net Profit Margin |
|---|
| Restaurants and Dining | 27.60% | 5.69% |
| Retail (General) | 24.27% | 2.79% |
| Retail (Online) | 42.53% | 4.95% |
| Software (Internet) | 58.58% | -5.60% |
15 more rowsA gross profit margin of over 50% is healthy for most businesses. In some industries and business models, a gross margin of up to 90% can be achieved. Gross margins of less than 30% can be dangerous for businesses with high gross costs.
Generally, a 10% operating profit margin is considered an average performance, and a 20% margin is excellent. It's also important to pay attention to the level of interest payments from a company's debt.
What's the difference between gross margin and operating margin? ›
Gross margin measures the return on the sale of goods and services, while operating margin subtracts operating expenses from the gross margin.
What does operating margin tell you? ›
What Is Operating Margin? The operating margin measures how much profit a company makes on a dollar of sales after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax. It is calculated by dividing a company's operating income by its net sales.
What is the difference between gross and net profit? ›
Net profit reflects the amount of money you are left with after having paid all your allowable business expenses, while gross profit is the amount of money you are left with after deducting the cost of goods sold from revenue. You need to calculate gross profit to arrive at net profit.
What is another name for operating profit? ›
Operating profit is also called operating income or earnings before interest and tax (EBIT). EBIT can include non-operating revenue, which is not included in operating profit. If a company doesn't have non-operating revenue, EBIT and operating profit will be the same.
What is more important, operating income or net income? ›
The difference between operation and net income comes down to what exactly is deducted from your startup's gross income. Operating income is only what you earn after direct and indirect costs are subtracted from gross profits. However, net income is your bottom line.
What is the major difference between gross and net profit net profit? ›
Net profit reflects the amount of money you are left with after having paid all your allowable business expenses, while gross profit is the amount of money you are left with after deducting the cost of goods sold from revenue.
Why is operating profit higher than gross profit? ›
However, certain extraordinary items can lead to negative operating expenses. For eg. Very large provision for doubtful debts could be reversed when those debts are recovered. In such cases operating profit could be higher than gross profit.
What is an example of operating profit? ›
Example of Operating Profit
10,00,000 from the sales of computer hardware. The company incurred operating expenses of Rs. 6,00,000, which include the cost of goods sold, salaries, rent, utilities, and other expenses related to production, administration, and selling activities.
What is the difference between net profit and net operating revenue? ›
Profits, often referred to as net profits, are quite literally placed at the bottom line on an income statement. Net profit represents the income remaining after all operating and other expenses are subtracted from net revenue. Net revenue only considers expenses directly tied to revenue.
