What's the difference between gross margin and net margin?

Gross margin is revenue minus cost of goods sold, divided by revenue — it shows profitability before overhead. Net margin also subtracts operating expenses, so it shows what is left after rent, salaries and marketing, before interest and tax. A business can have a strong gross margin and a weak net margin if its overhead is heavy.

What is considered a good profit margin?

It depends heavily on the industry. Grocery and general retail often run 1-3% net margin, restaurants and independent shops 3-9%, and software or professional services businesses can post 20-30% or higher because they carry little cost of goods. Compare your figure against your own trend and close competitors rather than a universal target.

Why is my gross margin high but my net margin low?

This usually means your operating expenses — rent, salaries, marketing, admin — are large relative to revenue even though production or purchasing costs are well controlled. It is common in businesses carrying a large office, a big sales team, or expensive premises, and it signals that cost control effort should focus on overhead rather than cost of goods.

Should cost of goods sold include staff wages?

Only wages for people directly involved in producing or delivering the product, such as factory labour or kitchen staff, belong in cost of goods sold. Administrative, sales and management salaries belong in operating expenses. Mixing the two makes gross margin meaningless when compared against another business or against your own prior periods.

Does profit margin include tax?

No. Both gross and net margin as calculated here sit above the tax and interest lines, so this net margin is closer to operating margin than to the profit margin shown after tax on a full income statement. If you need the after-tax figure, subtract interest expense and the tax charge from net profit before dividing by revenue.

How do I improve my net profit margin?

There are only three levers: raise prices without losing proportionally more volume, cut the direct cost of producing what you sell, or reduce operating overhead. Because overhead is usually the largest gap between gross and net margin for established businesses, reviewing recurring costs like leases, software subscriptions and staffing levels tends to move the needle fastest.

Profit margin calculator

This calculator turns three numbers off your income statement — revenue, cost of goods sold and operating expenses — into gross margin and net margin as percentages. Gross margin shows how much of each sales pound survives production before anything else is paid; net margin shows what is left once rent, payroll, marketing and the rest of the overhead have also been deducted, before tax and interest.

What counts as a healthy margin, by business type

There is no single benchmark because cost structures differ wildly by industry. A grocery retailer routinely runs net margins of 1-3% because volume is the whole game; a software company selling licences can post 70-80% gross margin and 20-30% net margin because there is almost no cost of goods once the code is written.

Restaurants and independent retailers typically land around 3-9% net margin after paying for stock, staff and rent. Professional services such as consultancies or agencies often sit higher, 15-25% net margin, because the main input is billable time rather than physical inventory.

Rather than chasing an industry-wide number, compare your own margin against your own history. A gross margin that has slipped from 45% to 38% over two years tells you input costs or pricing have moved even if the absolute figure still looks respectable next to a competitor.

Three businesses, worked through

A furniture maker books 850,000 in revenue, 510,000 in cost of goods (timber, hardware, direct labour) and 255,000 in operating expenses (showroom rent, admin, marketing). Gross profit is 850,000 minus 510,000, or 340,000, which is a 40% gross margin. Net profit is 340,000 minus 255,000, or 85,000, a 10% net margin.

A small cafe takes 120,000 in revenue against 84,000 of cost of goods (food, drink, packaging) and 24,000 of operating expenses (part-time wages, utilities). Gross profit is 36,000, a 30% gross margin, and net profit is 12,000, also a 10% net margin, even though the gross figure looked ten points thinner than the furniture maker's.

A mid-size distributor turns over 2,400,000, with 1,680,000 of cost of goods and 600,000 of operating expenses. Gross profit is 720,000, a 30% gross margin, but net profit is only 120,000, a 5% net margin — the same gross margin as the cafe, yet half its net margin, because overhead eats a larger share of every pound of revenue at this scale.

Why two businesses with equal gross margin can post very different net margin

Gross margin measures pricing power and production efficiency; net margin adds in how much overhead the business carries to run itself. The distributor and the cafe above both convert 30 cents of gross profit from every dollar of sales, but the distributor's fixed costs — warehousing, a sales team, logistics software — consume a much larger slice before anything reaches the bottom line.

This is why comparing only gross margin across two companies can be misleading. A retailer with a thin 25% gross margin but very lean overhead can out-earn a rival with a fat 45% gross margin buried under management layers and long leases.

Watching the gap between the two margins over time is often more useful than watching either number alone. A widening gap usually means overhead is growing faster than sales, which is the classic warning sign of a business scaling its costs ahead of its revenue.

Where the arithmetic stops telling the full story

Both margins here are calculated before interest and tax, so two companies with identical operating performance can report very different bottom-line profit once one carries debt and the other does not. Neither margin in this calculator is the same thing as free cash flow: a business can show a positive net margin while its cash is tied up in unpaid invoices or growing inventory.

The split between cost of goods and operating expenses is also a matter of accounting policy, not physics. A company that classifies warehouse staff as cost of goods will show a lower gross margin than one that classifies the same staff as an operating expense, even if the two businesses are identical in every other respect. Compare margins only against figures built the same way.

One-off items — a lawsuit settlement, a grant, a asset sale — can distort a single period's net margin badly. Looking at margin trends across three or four periods rather than trusting one quarter in isolation avoids reading too much into noise.

Reporting differences to watch for

US companies filing under GAAP and UK or EU companies filing under IFRS can classify certain costs, such as leases and some staff benefits, differently enough to shift gross margin by a point or two even for near-identical operations, so cross-border comparisons deserve a footnote check rather than a straight read of the headline percentage.

VAT or sales tax should be stripped out of revenue before it goes into this calculator; margins calculated on tax-inclusive turnover overstate revenue and understate the true margin.

Seasonal businesses should look at margin over a full trading year rather than a single quarter, since a retailer's Q4 margin driven by holiday volume can look nothing like its Q1 figure once the same fixed costs are spread over much lower sales.

Frequently asked questions

What's the difference between gross margin and net margin?: Gross margin is revenue minus cost of goods sold, divided by revenue — it shows profitability before overhead. Net margin also subtracts operating expenses, so it shows what is left after rent, salaries and marketing, before interest and tax. A business can have a strong gross margin and a weak net margin if its overhead is heavy.
What is considered a good profit margin?: It depends heavily on the industry. Grocery and general retail often run 1-3% net margin, restaurants and independent shops 3-9%, and software or professional services businesses can post 20-30% or higher because they carry little cost of goods. Compare your figure against your own trend and close competitors rather than a universal target.
Why is my gross margin high but my net margin low?: This usually means your operating expenses — rent, salaries, marketing, admin — are large relative to revenue even though production or purchasing costs are well controlled. It is common in businesses carrying a large office, a big sales team, or expensive premises, and it signals that cost control effort should focus on overhead rather than cost of goods.
Should cost of goods sold include staff wages?: Only wages for people directly involved in producing or delivering the product, such as factory labour or kitchen staff, belong in cost of goods sold. Administrative, sales and management salaries belong in operating expenses. Mixing the two makes gross margin meaningless when compared against another business or against your own prior periods.
Does profit margin include tax?: No. Both gross and net margin as calculated here sit above the tax and interest lines, so this net margin is closer to operating margin than to the profit margin shown after tax on a full income statement. If you need the after-tax figure, subtract interest expense and the tax charge from net profit before dividing by revenue.
How do I improve my net profit margin?: There are only three levers: raise prices without losing proportionally more volume, cut the direct cost of producing what you sell, or reduce operating overhead. Because overhead is usually the largest gap between gross and net margin for established businesses, reviewing recurring costs like leases, software subscriptions and staffing levels tends to move the needle fastest.

Sources

U.S. Bureau of Labor Statistics — Producer Price Index news release — Tracks changes in input and output prices by industry, useful context for why cost-of-goods and gross margin shift over time (updated monthly, 2025).
IRS — Instructions for Schedule C (Form 1040) — Defines how U.S. sole proprietors report gross receipts, cost of goods sold and business expenses, the same line items this calculator uses (tax year 2024 revision).