Finance · 3 min read
Gross Margin vs Net Margin: What's the Difference?
Gross margin tells you how much you keep from each sale after the direct cost of making or buying what you sold. Net margin tells you how much you keep after everything: rent, wages, marketing, interest and tax. Gross margin is about your product and pricing. Net margin is about whether the whole business works.
The three margins on one business
A small online shop has a year like this:
| Line | Amount | Margin |
|---|---|---|
| Revenue | $200,000 | — |
| Cost of goods sold (stock, packaging, shipping to customers) | $120,000 | — |
| Gross profit | $80,000 | Gross margin 40% |
| Operating expenses (wages, rent, software, ads) | $55,000 | — |
| Operating profit | $25,000 | Operating margin 12.5% |
| Interest and tax | $7,000 | — |
| Net profit | $18,000 | Net margin 9% |
So the shop keeps 40 cents of every dollar after paying for the products, but only 9 cents once everything else is paid.
The formulas
- Gross margin = (revenue − cost of goods sold) ÷ revenue
- Operating margin = operating profit ÷ revenue
- Net margin = net profit ÷ revenue
For a single product, the profit margin calculator gives you gross margin and markup from cost and price.
What each one tells you
Gross margin answers: are my prices high enough relative to my product costs? If it's falling, suppliers may be raising prices, you might be discounting too much, or shipping costs are eating in.
Operating margin answers: is the business efficient? It shows whether overheads are under control as you grow.
Net margin answers: after everything, is this worth it? It's the one investors and lenders care most about, and the one that ultimately pays you.
A healthy gross margin can hide a weak net margin
It's common for a business to have great product margins and still lose money. Say a coffee shop has a 70% gross margin on drinks. Sounds brilliant, until rent, staff and equipment take 68% of revenue. Net margin: about 2%, before tax. Improving it might mean raising prices, cutting overheads or selling more per customer, not buying cheaper beans.
What counts as cost of goods sold?
COGS covers costs that rise directly with each sale: materials, stock purchases, direct labour on production, and often packaging and shipping to customers. Rent, marketing and office salaries are operating expenses, because they don't change much with each extra sale. Where you draw the line varies by business, but be consistent from year to year so the numbers are comparable.
Which margin should you track?
All three, but at different speeds:
- Gross margin: per product, whenever prices or costs change.
- Operating margin: monthly, to watch overhead creep.
- Net margin: quarterly and yearly, to judge the whole business.
Wondering what "good" looks like for your type of business? See what is a good profit margin for a small business?, and for setting prices in the first place, cost-plus pricing.
Frequently asked questions
What is the difference between gross margin and net margin?
Gross margin subtracts only the cost of goods sold from revenue; net margin subtracts all costs, including overheads, interest and tax.
How do you calculate gross margin?
Subtract cost of goods sold from revenue, then divide by revenue. $80,000 gross profit on $200,000 revenue is a 40% gross margin.
Can a business have a high gross margin but low net margin?
Yes. High overheads such as rent, wages and marketing can absorb most of the gross profit, leaving a thin net margin.
What is operating margin?
Operating profit (after cost of goods and operating expenses, before interest and tax) divided by revenue. It shows how efficiently the business runs.