The terms “gross profit” and “gross margin” are often used interchangeably to describe how much a business generates from its activities. Regardless of their size or market, businesses must purchase products and services to conduct their own money-money activities. A retail store, for instance, must purchase inventory from a vendor so that it can resell the products to its customers. While gross profit and gross margin offer insight into a business’s profits, they aren’t necessarily the same. So, what’s the difference between gross profit and gross margin in accounting?
Gross Profit Explained
Gross profit is an accounting metric that shows how much profit a business generates from its activities. It’s calculated by taking the business’s net sales and subtracting that number by its Cost of Goods Sold (COGS). If a business generated $200,000 during a given month and its COGS was $60,000, its gross profit would be $140,000 for that month. Gross profit uses a simple formula to reveal how much profit a business generated during a particular period.
Gross Margin Explained
Also known as gross profit margin, gross margin is another accounting metric that, like gross profit, shows much much profit a business generates from its activities. With that said, it uses a different formula than gross profit. Gross margin is calculated by taking the business’s gross profits and dividing that number by its net sales. Therefore, it uses a slightly different formula that ignores certain expenses.
Differences Between Gross Profit and Gross Margin
The main difference between gross profit and gross margin is that the former takes into account all of the business’s expenses, whereas the latter does not. With gross profit, all expenses associated with a business’s money-money activities are factored into the equation. With gross margin, indirect expenses — advertising, administrative fees, interest, tax, etc. — are ignored. These expenses are ignored when calculating gross margin, so a business’s gross margin is typically smaller than its gross profit for that same period.
You can use gross profit or gross margin to track your business’s financial health and well-being. Gross margin, however, ignores the aforementioned expenses, so it offers a more cloudy and altered representation of your business’s finances. That’s why, in fact, it’s referred to as “gross margin” rather than simply “gross profit.” Hopefully, this gives you a better understanding of how gross profit and gross margin differ.
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