What is the difference between gross margin and net margin?

Gross margin tells you whether the product makes money. Net margin tells you whether the business does. They answer different questions and are frequently confused when people quote "margin".

Gross margin. Revenue minus cost of goods sold, expressed as a percentage of revenue. Cost of goods sold is the direct cost of what you sold — materials, manufacturing, the wholesale price of stock, direct delivery cost, or in a service business the cost of the people delivering the work.

A product sold for £100 costing £40 to make has a 60% gross margin.

Why it is the most important number in a young business. Gross margin is what pays for everything else. If it is too thin, no amount of volume will produce a profit, because overheads have to come out of it. A business with a structurally low gross margin cannot be fixed by growing — growth multiplies a small number.

Net margin. Net profit as a percentage of revenue — after overheads, interest and tax. This is what the business actually keeps.

The gap between them is your overhead, and it is largely fixed in the short term, which produces operating leverage: once overheads are covered, additional gross profit falls almost entirely to the bottom line. This is why a business can move from loss to healthy profit over a small increase in revenue — and why the reverse happens just as fast.

Why margins differ so much by industry. Software has very high gross margins because the marginal cost of another copy is near zero. Grocery retail runs at a few percent net margin and works on volume and turnover. Comparing margins across industries tells you nothing useful; comparing against direct competitors does.

Markup is not margin, and confusing them is a genuine and expensive error. A 50% markup on a £40 cost gives a £60 price and a 33% margin. Pricing off markup while budgeting off margin leaves a hole.

Contribution margin — revenue minus all variable costs — is the more useful figure for pricing and break-even decisions.

General information, not financial advice.