How Do You Calculate Gross Margin and Net Margin? What Are the Formulas?

Simply put, Gross Margin = (Revenue − COGS) ÷ Revenue × 100%^[1]. It answers: For every ¥100 of sales, after deducting direct costs like raw materials and direct labor, how much is left?
For example: You run a bubble tea shop. A cup sells for ¥20, and the raw materials (milk, tea, cup) cost ¥6. Then gross margin = (20-6)÷20 = 70%. That 70% is gross profit—before rent, employee wages, utilities, etc.

Here's a more detailed example: Suppose you sell handmade leather bags. Each bag sells for ¥500, direct material costs (leather, hardware, zippers) are ¥150, and the seamstress's piece-rate wage is ¥50. So COGS is ¥200, and gross margin = (500-200)/500 = 60%. That 60% must cover store rent, marketing, management salaries, etc., and whatever is left is net profit.

Net Margin = Net Profit ÷ Revenue × 100%^[2]. Net profit is the money that actually ends up in your pocket after deducting all expenses—rent, wages, advertising, interest, taxes. Using the bubble tea example: if operating expenses (rent, labor, etc.) allocated per cup are ¥8, and interest and taxes total ¥2, then net profit = 20-6-8-2 = ¥4, and net margin = 4÷20 = 20%.

Note: Gross margin, operating margin, and net margin decrease step by step: Gross Margin ≥ Operating Margin ≥ Net Margin^[5]. Operating margin deducts operating expenses from gross margin, and net margin further deducts interest and taxes^[4]. To understand the structure of the income statement, check out our previous article Income Statement, Balance Sheet, and Cash Flow Statement Explained.

Does a High Gross Margin Mean the Company Is Very Profitable?

Not necessarily! This is the most common misunderstanding. A high gross margin only means the product itself has a 'fat margin,' but the company might have high operating expenses (e.g., heavy advertising, a large sales team), heavy interest burdens, or high taxes, resulting in a very low net margin or even a loss.

For example: A software company has a gross margin of 80%, but to capture market share, it spends 60% of revenue on sales and R&D. After interest and taxes, its net margin might be only 5%. Meanwhile, a supermarket with a gross margin of only 20% might achieve a net margin above 5% due to extremely efficient operations and tight cost control. So, high gross margin ≠ profitable company; net margin is the final answer.

Another example: A luxury goods company might have a gross margin of 70%, but to maintain its brand image, it spends heavily on advertising, store renovations, and VIP services, leaving a net margin of only about 10%. In contrast, a discount retailer with a gross margin of only 25% can achieve a net margin of 8% through extreme cost control (e.g., lean staffing, efficient logistics). Therefore, looking only at gross margin can overestimate a company's profitability.

Simply put, gross margin tells you whether the product is profitable; net margin tells you whether the entire company is profitable. If you only focus on gross margin, you might be misled. It's recommended to also look at the full income statement in How to Read US Stock Earnings Reports.

What Is a Good Net Margin? Is 10% Healthy?

Net margin varies greatly by industry, so there is no absolute standard. However, a rough rule of thumb: net margin of 5% or below is generally low, around 10% is healthy/average, and above 20% is considered excellent^[6].

But don't apply this rule blindly. For example, the average net margin in the supermarket industry is only 1%-3%^[8]. If a supermarket achieves 5%, it's already a top performer. Meanwhile, software companies often have net margins above 20% because of low marginal costs. So, always compare with companies in the same industry.

Also, the blended net profit margin for the S&P 500 in Q1 2026 reached 13.4%, a record high^[10], indicating that the overall market's profitability is at a historical peak. You can use this as a reference, but don't forget to look at specific industries.

For example: Suppose you see a tech company with a net margin of 15%, while the industry average is 12%. That's a good sign. But if a supermarket has a net margin of 15%, be cautious—it might be due to one-time gains or accounting adjustments, because the normal level for supermarkets is far lower.

Why Can Software Companies Have Gross Margins of 80% While Supermarkets Only Have 20%?

The core reason is different cost structures. For software companies, the main cost is R&D salaries, but once the product is developed, the marginal cost of selling one more copy is nearly zero (server costs are very low), so COGS is low, leading to high gross margins. For example, the software & programming industry's trailing twelve-month gross margin as of Q2 2026 was about 88.86%^[7].

Supermarkets, on the other hand, sell physical goods. The purchase cost accounts for the vast majority of the selling price, and they also bear direct costs like warehousing, logistics, and spoilage. So gross margins are inherently low. The average gross margin for the supermarket industry is typically 20%-30%, and net margins are only 1%-3%^[8].

That's why gross margin and net margin cannot be compared across industries—different business models make the numbers incomparable^[12]. For instance, Apple's overall gross margin for fiscal 2025 was 46.9%, with product gross margin at 36.8% and services gross margin as high as 75.4%^[9]. Services are more profitable than hardware, but that doesn't mean Apple's product gross margin is bad.

Another example: An airline might have a gross margin of only 10%-15% because fuel, aircraft depreciation, and airport landing fees are high direct costs. In contrast, a consulting firm can have a gross margin above 80% because its main cost is labor, which is flexible. Therefore, cross-industry gross margin comparisons are meaningless.

Are Gross Margin and Markup the Same Thing?

No! This is one of the most common confusions for beginners. Simply put: Gross margin is profit as a percentage of the selling price, while markup is profit as a percentage of cost.

Example: Cost = ¥70, Selling Price = ¥100. Gross margin = (100-70)/100 = 30%; Markup = (100-70)/70 ≈ 42.9%^[13]. The denominators are different, so the results are completely different. If you mistake markup for gross margin, you'll overestimate your profit space.

In pricing and financial analysis, it's crucial to distinguish between these two concepts. Many retailers use markup for pricing, but financial statements use gross margin.

For instance, a clothing store buys a shirt for ¥50 and sells it for ¥100. The owner says, 'I marked it up 100%,' which is markup. But the gross margin is only 50%. If the owner mistakenly thinks the gross margin is also 100%, they would incorrectly believe the profit margin is huge and underestimate the importance of cost control.

When Reading Financial Reports, Should I Focus More on Gross Margin or Net Margin?

You should look at both, but with different focuses. Gross margin reflects the competitiveness of the company's core product or service—if gross margin is declining, it may signal pricing pressure or rising costs, which is a red flag. Net margin reflects the company's overall operational efficiency and financial health—it's the ultimate measure of profitability^[14].

I recommend analyzing in this order: first check whether gross margin is stable or improving, then look at operating margin (to gauge management efficiency), and finally net margin (to see the final profit power). If gross margin is high but net margin is low, it suggests that operating expenses or financial costs are too high, and you need to dig deeper.

Additionally, you can use the industry profitability database maintained by Professor Damodaran at New York University^[11] to compare gross margin, operating margin, and net margin benchmarks with peer companies. For more on revenue and net income, read Revenue vs Net Income: What's the Difference?.

For example, if a company's gross margin has dropped from 50% to 40% over three consecutive years, and net margin has fallen from 10% to 5%, the problem likely lies in product competitiveness. If gross margin is stable but net margin is declining, operating expenses may be out of control.

What Are Common Misconceptions About Gross Margin and Net Margin?

Misconception 1: High gross margin = highly profitable company. As we've said, high gross margin with high operating expenses can lead to a low net margin.

Misconception 2: Comparing gross margins across industries. A software company's 80% gross margin and a supermarket's 20% are not comparable; you must compare within the same industry^[12].

Misconception 3: Confusing gross margin with markup. The denominators differ, leading to very different numbers; using the wrong one can cause pricing or valuation errors^[13].

Misconception 4: Only looking at net margin and ignoring others. Although net margin is comprehensive, it can be distorted by one-time gains or losses. It's best to look at gross margin and operating margin together.

Misconception 5: Thinking a higher net margin is always better. An excessively high net margin might mean the company has cut necessary R&D or marketing investments, which can harm long-term competitiveness. For example, a tech company slashes R&D to boost short-term profit, raising net margin from 15% to 25%, but its future products may lose their edge.