It’s one of the most frustrating situations in business: you’re busier than ever, sales are up, and yet there’s less profit at the end of the year.
The answer is almost always hidden in two numbers: gross margin and net profit. Understanding the difference between them is one of the most useful skills a business owner can have.
What Is Gross Margin?
Gross margin shows how much you keep from each sale after paying the direct costs of producing or buying what you sold.
Formula: Gross Margin (%) = (Revenue − Cost of Goods Sold) ÷ Revenue × 100
Direct costs typically include:
- Merchandise or raw materials
- Direct labour (for example, kitchen staff in a restaurant or crews on a construction job)
- Subcontractors
- Freight and packaging
Gross margin answers this question: Is each sale profitable enough?
What Is Net Profit?
Net profit is what’s left after all expenses: direct costs, overhead, interest, and taxes.
Formula: Net Profit Margin (%) = Net Profit ÷ Revenue × 100
Net profit answers this question: Is the business as a whole profitable?
Example: Sales Up 20%, Profit Down
| Last year | This year | |
|---|---|---|
| Revenue | $500,000 | $600,000 |
| Cost of goods sold | $300,000 | $390,000 |
| Gross profit | $200,000 (40%) | $210,000 (35%) |
| Operating expenses | $150,000 | $170,000 |
| Interest and taxes | $15,000 | $12,000 |
| Net profit | $35,000 (7%) | $28,000 (4.7%) |
Sales grew by $100,000, but net profit fell by $7,000. Why?
- Gross margin dropped from 40% to 35%. Direct costs grew faster than sales, perhaps because supplier prices rose and selling prices didn’t.
- Overhead grew by $20,000 to support the extra volume.
More sales at a lower margin, plus higher overhead, meant more work for less money.
Common Reasons Margins Shrink
- Supplier price increases not passed on to customers
- Discounting to win or keep business
- Labour costs rising faster than prices
- Waste, theft, or spoilage, especially in restaurants and retail
- Underpriced jobs or contracts, common in construction and transportation
- A shift in sales mix toward lower-margin products or services
How to Protect Your Margins
- Track gross margin monthly, by product, service, or job if possible.
- Review pricing regularly, at least once a year and whenever costs rise.
- Know your true costs before quoting.
- Negotiate with suppliers, or look for alternatives.
- Watch overhead creep: every new expense should earn its place.
- Focus on profitable growth, not just more sales.
Frequently Asked Questions
What is a good gross margin?
It depends heavily on your industry. Compare yourself with similar businesses and, most importantly, with your own past results.
What is the difference between gross profit and net profit?
Gross profit subtracts only direct costs from revenue. Net profit subtracts all costs, including overhead, interest, and taxes.
Can a business have a high gross margin and still lose money?
Yes, if overhead, debt costs, or owner pay are too high for the volume of sales.
Find Out Where Your Profit Is Going
AccoClariT helps business owners understand margins, labour costs, and profitability, so growth actually leads to better results. Book your free 45-minute consultation.