Bill Hanna breaks down gross margin versus profit margin using a $500,000 revenue example. Gross margin (60%) shows what's left after production costs; profit margin (20%) shows what's left as actual profit. Gross margin measures product profitability, profit margin measures the whole business.
Hey guys, welcome back to another Finance Byte with your favorite financial controller, Bill Hanna, here. Today we'll talk about an important distinction you need to make as a CFO or controller between two financial metrics. The first one is the gross margin and the second is profit margin. So imagine that you have a company with $500,000 in sales. The cost to produce its goods or COGS is $200,000, and that leaves a gross profit of $300,000. Now let's go ahead and calculate What's going to be our gross margin? That's calculated as, uh, revenue minus COGS, which is gross profit, divided by revenue. So in this case, we are dividing $300,000 by revenue $500,000, and that gives us 60%, which means that out of every dollar that we sell, we make about 60 cents in gross profit. Now, with profit margin, the calculation is net income divided by revenue. Let's say our net income in this case is $100,000, and we're going to divide that also by revenue, $500K, and that's going to give us 20%. Now, what does that mean? That means that for every dollar that we sell, we make $0.20 in net profit. So in summary, this here gross margin tells us about the profitability of the product, while net margin or net profit margin Tells us about the profitability of the overall business. If you like this Finance Byte and want to learn more, uh, go ahead and follow the channel and check out the Controller Academy for in-depth courses in finance and accounting.
