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Gross Margin vs. Net Margin: What Each Number Tells You About Your Business
Quick summary
Gross margin measures profitability before operating expenses, while net margin measures what remains after the full cost of running the business.
- Gross margin shows the percentage of revenue left after direct costs.
- Net margin shows the percentage left after all recorded expenses.
- Gross margin helps evaluate pricing and delivery efficiency.
- Net margin reflects the wider cost of operating and financing the business.
- Both percentages should be compared over time and against relevant industry information.
Revenue growth can feel like success. But if labour, materials, subcontractors, software, rent and financing costs grow even faster, the business may be working harder without becoming more profitable.
Gross margin and net margin help owners move beyond top-line sales and understand how much of each revenue dollar remains at different stages of the business.
What is gross margin?
Gross margin is the percentage of net revenue remaining after direct costs are subtracted. Direct costs are costs closely connected to producing a product or delivering a service.
Gross margin = (Net revenue − Direct costs) ÷ Net revenue × 100
BDC’s gross profit margin guidance describes the measure as an indicator of financial health and production efficiency. It is especially useful for reviewing pricing, labour, materials and other variable costs.
What is net margin?
Net margin is the percentage of revenue remaining after all recorded costs and expenses are deducted. Depending on the financial statements, these can include direct costs, operating expenses, depreciation, interest and taxes.
Net margin = Net income ÷ Net revenue × 100
BDC describes net profit margin as the portion of each sales dollar left after the wider cost of running the company is considered.
Gross margin vs. net margin
| Gross margin | Net margin |
|---|---|
| Subtracts direct costs | Subtracts all recorded expenses |
| Focuses on pricing and delivery efficiency | Focuses on overall profitability |
| Does not include general operating costs | Includes operating and other expenses |
| Appears higher on the profit and loss statement | Appears near the bottom of the statement |
| Useful for product, service and project economics | Useful for company-wide financial performance |
A simple margin example
Assume a business reports:
| Item | Amount |
|---|---|
| Net revenue | $200,000 |
| Direct labour, materials and subcontractors | $120,000 |
| Gross profit | $80,000 |
| Operating and other expenses | $55,000 |
| Net income | $25,000 |
Gross margin calculation
($200,000 − $120,000) ÷ $200,000 × 100 = 40%
The business retains 40 cents from each revenue dollar after direct costs. That amount must cover operating expenses, financing costs, taxes and profit.
Net margin calculation
$25,000 ÷ $200,000 × 100 = 12.5%
The business retains 12.5 cents from each revenue dollar after all recorded expenses in this example.
What counts as a direct cost?
The answer depends on the business model and how financial reports are structured. Direct costs may include:
| Business type | Possible direct costs |
|---|---|
| Construction | Project labour, materials, subcontractors and equipment rentals |
| Retail | Inventory sold, freight and certain fulfilment costs |
| Food and beverage | Ingredients, packaging and direct production labour |
| Professional services | Billable labour or contractors directly delivering client work |
| Manufacturing | Raw materials, production labour and manufacturing overhead under the reporting method used |
General administration, marketing, rent and office software are commonly treated as operating expenses rather than direct costs, but the correct structure depends on the company and reporting purpose.
Why can revenue grow while profit falls?
- Material or supplier prices increased
- More discounts were offered
- Labour took longer than estimated
- Overtime or rework increased
- Low-margin products made up more of the sales mix
- Unapproved work was completed without being billed
- Customer acquisition costs increased
- New employees or locations added overhead before revenue caught up
- Interest and financing costs rose
This is why revenue should be reviewed alongside gross profit, gross margin, operating expenses and net income.
How to analyze gross margin
Compare the same category over time
Compare monthly, quarterly and year-to-date results using consistent categories. A declining margin deserves investigation even when total gross profit dollars are increasing.
Review pricing and direct costs separately
Margin can fall because prices are too low, costs are too high or the sales mix has changed. Separate these causes before deciding what to change.
Break the total into meaningful lines
Company-wide margin can hide important differences. Review margin by product, service, project, customer type or location when the bookkeeping and operational systems support it.
How to analyze net margin
- Compare the result with prior periods and the budget
- Separate recurring expenses from one-time items
- Review payroll and overhead as a percentage of revenue
- Look for subscriptions and expenses that no longer create value
- Understand the effect of interest, depreciation and taxes
- Compare against relevant industry information rather than unrelated businesses
BDC notes that margin standards vary by sector, company size and region. A “good” margin is therefore contextual. The strongest comparison is often against the company’s own targets, history and relevant peers.
How to improve gross margin
- Review pricing and discount practices
- Renegotiate supplier pricing or payment terms
- Reduce material waste and rework
- Improve labour scheduling and productivity
- Track change orders and billable extras
- Shift focus toward stronger-margin products or services
- Improve estimating and job-costing processes
How to improve net margin
- Improve gross margin first
- Review fixed and recurring expenses
- Match hiring and overhead growth to realistic revenue capacity
- Reduce duplicate or unnecessary software and services
- Improve accounts receivable to reduce collection costs and bad debt
- Review financing costs and debt structure
- Use budgets and variance reviews to identify problems sooner
Common margin-reporting mistakes
- Placing direct costs in operating expenses
- Changing categories between periods
- Failing to record supplier bills in the correct month
- Leaving project labour or subcontractors unassigned
- Comparing gross profit dollars with gross margin percentages
- Assuming a higher margin is always better without considering volume
- Comparing results with businesses that have different operating models
How Agile helps make margin reporting more useful
Margin analysis depends on consistent bookkeeping. Revenue, direct costs and operating expenses must be recorded in the right period and assigned to useful categories.
Agile keeps bookkeeping current, completes reconciliations and provides financial reports with CPA oversight. For businesses with the right source information, this creates a stronger foundation for reviewing margins, costs and profitability. Explore bookkeeping for professional services, construction bookkeeping or retail bookkeeping.
Frequently asked questions
What is gross margin?
Gross margin is the percentage of net revenue left after direct costs are subtracted.
What is net margin?
Net margin is the percentage of net revenue left after all recorded expenses are deducted from revenue.
What is the difference between gross margin and net margin?
Gross margin focuses on revenue and direct costs. Net margin includes the wider cost of running and financing the business.
How do you calculate gross margin?
Subtract direct costs from net revenue, divide the result by net revenue and multiply by 100.
How do you calculate net margin?
Divide net income by net revenue and multiply by 100.
Is gross profit the same as gross margin?
No. Gross profit is a dollar amount. Gross margin expresses gross profit as a percentage of net revenue.
Why would gross margin decrease?
Possible causes include rising direct costs, lower prices, discounts, rework, inefficient labour, unbilled work or a shift toward lower-margin sales.
Which is more important: gross margin or net margin?
They answer different questions. Gross margin evaluates the economics of delivering products or services, while net margin evaluates overall company profitability.
Know where each revenue dollar is going
Agile keeps revenue and expenses organized into consistent categories so your financial reports can support better pricing and cost decisions.
Sources and further reading
This article provides general educational information. It is not financial, tax or legal advice for a specific business.