There are 3 most common types of profit margins: gross profit margin, operating profit margin, and net profit margin. They all offer valuable insights into your financial health that business owners, accountants, investors, lenders, and creditors can rely on to make decisions.
Let’s dive into each of them and see how they’re different.
Gross profit margin
Gross profit is how much money you got after deducting the cost of goods sold (COGS) from the revenue.
Cost of goods sold is the direct cost required in the production of goods, including materials, labor, supplies, and factory overheads.
You can quickly calculate the gross profit by this formula:
Gross profit = total revenue – cost of goods sold
After getting the gross profit, you can find out the gross profit margin with the below calculation:
Gross profit margin = (gross profit / revenue) x 100%
Gross profit margin usually has more value to understand the profitability of a specific product rather than the entire business. This is because your fashion retail needs to take into account many other operating costs. Thus, if you have high operating expenses, your bottom line may suffer even though your gross profit margin may seem good.
Operating profit margin
Operating profit is the remained revenue after subtracting the COGS and the operating expenses (OPEX).
Different from COGS, operating expenses are the indirect costs that support your daily business operation, such as rent, utilities, payroll, marketing costs, and software.
Follow this formula to calculate your operating profit:
Operating profit = revenue – cost of goods sold – operating expenses
Next, determine your operating profit margin:
Operating profit margin = (operating profit / revenue) x 100%
To fully see your apparel’s health, you should focus on the operating profit or net profit margin.
Net profit margin
Net profit is your bottom line — the most important metric for any business. It is what you keep after deducting COGS, OPEX, interest, and taxes.
This is the formula for net profit:
Net profit = total revenue – COGS – OPEX – interest – taxes
Then, calculate the net profit margin based on the percentage of revenue:
Net profit margin = (net profit / revenue) x 100%
Net profit margin is the best measure of the profitability of a company. It reports the final profit ratio you keep for yourselves after accounting for all sales and costs. Thus, the net profit margin is the most preferred metric among the 3 types of profit margin to evaluate the performance of a retail business.