What's the Difference Between Gross Margin and Gross Profit?
As I work with retailers, I am noticing a trend where the terms gross margin and gross profit are being used interchangeably, but they are not interchangeable terms. While they are measuring similar metrics, Gross margin is measuring the % (or $) of the comparison of a product's cost to its sell price. Whereas Gross Profit is measuring the % (or $) of profit from the sale of the product.
First, you must understand that both of these terms can be calculated as either a $ amount or a %.
In fact, when I was a COO for a retail company, I used to look at the gross margin in both $'s and %. The reason was that many of the products had great margin %, but the sale price was so low, that the actual $s generated to run the business were not that much. In other words, I could get very excited seeing 65% margins on accessories, but accessories only made up 10% of the total sales in the stores. So exciting to see those high margins, but could be misleading.
Gross profit is the Total Sales minus the Cost of generating that revenue. In other words, gross profit is sales minus cost of goods sold. It tells you how much money you would have made if you didn’t pay any other expenses such as salaries, rent, utilities, etc. So it looks like this
Sales - COGS (Cost of Goods Sold = Gross Profit $
GAAP rules require that gross profit be broken out and clearly labeled on all P&L statements, so this is one you will want to know.
Gross Margin is the Gross Profit calculation from above divided by Total Sales. So, if your store did $500,000 in sales and had $250,000 in gross profit, then you have a gross margin of 50% ($250,000 / $500,000.)
(Gross Profit / Sales) x 100 = Gross Margin %
One of the key components of this examination is the health of a store.
For example, if Store A and B have the same sales, yet Store A's gross margin is 50% and Store B's gross margin is 55%, which is the better store? Trick question. In regards to efficiency with inventory, Store B is the winner. But, Store B could have higher overhead costs or pay its employees $2 more per hour than Store A so even though it generated 5% more in gross margin, it still made the same Net Profit for the year.
Now that last part may seem confusing, but it is not. If I am selling TVs and I have a gross margin of 30% and my competitor is selling TVs but has a gross margin of 40% does that mean I am doing something wrong? Possibly. The key thing to see here is that because you have the gross margin % to relate too, it does make you stop and examine what you have been doing, doesn't it?
A store can have a high gross margin, but low revenues. Or low gross margins, but high revenues. Either way, the math could turn out the same on the P&L. Whenever you go to a bank for a loan or line of credit, both of these numbers are going to be important to the bank. They will be able to tell quickly if your store will be able to repay the loan based on your gross margin and gross profit.
Last note, the biggest impactor on gross margin in your store is your marketing. I have had many retailers tell me how great the weekend was because they had a big sales event. But, that just means they gave away a bunch of margin. For example, compare the two stores below:
|Sales||Gross Margin||Gross Profit|
What you see illustrated here is that the $3,000 extra dollars for the weekend sales yielded less gross profit than the same period a week ago when there was no sale. So, while the higher sales volume gets us excited, when it comes to marketing, it comes with a price.
One other note, most accountants will look at Net Gross Profit, which is relating the total amount of profit dollars you generated AFTER all the expenses have been paid. Again, many retailers could be very profitable, but they put themselves into bad leases or fail to control expenses.
So a retailer can have the best margins in the world, but you also need to know how to manage costs to be successful. After all, in retail, cash is king!