What's the Difference Between Gross Margin and Gross Profit?
If you're noticing a trend where the terms gross margin and gross profit are being used interchangeably, you're noticing two terms being used interchangeably when they shouldn't be. While they measure similar metrics, gross margin is measuring the percentage (or dollar amount) of the comparison of a product's cost to its sale price, whereas gross profit is measuring the percentage (or dollar amount) of profit from the sale of the product.
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. In the simplest of terms, 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 minus COGS (Cost of Goods Sold) = Gross Profit in Dollars
It's worth noting that GAAP rules require that gross profit be broken out and clearly labeled on all P&L statements.
Gross margin is the gross profit 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 percent.
(Gross Profit / Sales) x 100 = Gross Margin Percent
One of the key components of this examination is the health of a store. For example, if Store A and Store B have the same sales, but Store A's gross margin is 50 percent and Store B's gross margin is 55 percent, 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 Store B generated 5 percent more in gross margin, it still may have made the same Net Profit for the year.
If this seems confusing, consider the following. If you're selling TVs and have a gross margin of 30 percent and your competitor is selling TVs but has a gross margin of 40 percent does that mean you are doing something wrong? Possibly. The key thing to see here is that because you have the gross margin percentage to relate too, it does make you stop and examine what you're doing,
A Word About P&L
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.
On yet another note, most accountants will look at net gross profit, which is relating the total amount of profit dollars you generated "after" all of your expenses have been paid. Again, many retailers could be very profitable, but they put themselves into bad leases or fail to control escalating expenses. In the end, a retailer can have the best margins in the world, but you also need to know how to manage costs to be successful.
Whether you're selling $3,000 automated beds with remote control, or discount mattresses, in retail, cash is king!