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On your company's revenue statement, you should keep track of two common profit margin ratios: gross margin and net margin.
These figures show how well your company converts revenue into profit and are useful in determining your company's financial health.
Gross margin and net margin are two common profit margin ratios you should track on your company’s income statement. These numbers indicate how good your business is at converting revenue into profit and are important in assessing the financial health of your business.
What is Gross Margin?
Calculating gross margin will help give you an idea of how efficiently you are running your business. Keep track of this number over time to see how you’re doing from quarter to quarter. Consistent gross margin percentages over time indicate good business health, whereas fluctuating percentages may be a sign that that your business has some weak points.
When calculating gross margin, it is important to keep in mind that average percentages will vary based on industry and current market factors. Keep an eye on your competitors and industry trends to get a good idea of realistic numbers you can compare yourself to.
How to Calculate Gross Margin
Gross Margin = (Total Revenue – Cost of Goods Sold)/Total Revenue x 100
Gross margin is your total revenue minus cost of goods sold, divided by your total revenue multiplied by 100. It is always expressed as a percentage.
Total revenue: income generated from normal business operations over a specific period of time
Cost of goods sold (COGS): the direct costs of producing the goods or services your company sells. This includes the cost of materials and labor directly used to create the good or service. It does not include indirect or fixed costs such as overhead sales and marketing, rented office space, etc.
For example, if your quarterly revenue is $50,000 and your COGS is $40,000, you would calculate your gross margin as $50,000-$40,000/$50,000 x 100 = 20%.
What is Net Margin?
Net margin takes into account all of your business expenses, not just COGS, to compare bottom-line net profit to revenue. Your net margin will almost always be lower than your gross margin, because operating costs and additional expenses are subtracted. Net margin measures how much of your net income (your profit) is generated from revenue. Like gross margin, this percentage also varies by industry.
How to Calculate Net Margin
Net Margin = Net Income/Total Revenue x 100
Net margin is your net income divided by total revenue multiplied by 100. It is always expressed as a percentage.
Net income: your total revenue minus the cost of all goods, operating expenses, interest, taxes, office rental space, etc.
Total revenue: income generated from normal business operations during a specific period of time
For example, if your total revenue is $50,000 and your COGS and operating expenses total $43,000, your net income is $7,000. To calculate net profit margin, $7,000/$50,000 x 100 = 14%. In this example, 14% of your total sales revenue is profit.
The information provided in the MBO Blog does not constitute legal, tax or financial advice. It does not take into account your particular circumstances, objectives, legal and financial situation or needs. Before acting on any information in the MBO Blog you should consider the appropriateness of the information for your situation in consultation with a professional advisor of your choosing.