Gross profit margin and operating profit margin are two metrics used to measure a company’s profitability. The difference between them is that gross profit margin only figures in the direct costs involved in production, while operating profit margin includes operating expenses like overhead. Both metrics are important in assessing the financial health of a company.
Gross Profit Margin
Gross profit margin shows the percentage of revenue after subtracting the cost of goods sold involved in production. The cost of goods sold is the amount it costs a company to produce the goods or services that it sells. Gross margin shows how well a company generates revenue from the direct costs like direct labor and direct materials involved in producing their products and services.
Gross profit margin is calculated by taking total revenue and subtracting the cost of goods sold. The difference is divided by total revenue. You can multiply the result by 100 since gross margin is typically shown as a percentage.
Gross Profit Margin
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begin{aligned} &text{Gross Profit Margin} = frac { text{Revenue} – text{COGS}}{ text{Revenue}} times 100 \ &textbf{where:} \ &text{COGS} = text{Cost of goods sold} \ end{aligned} Gross Profit Margin=RevenueRevenue−COGS×100where:COGS=Cost of goods sold
Operating Profit Margin
Operating profit is located further down the income statement and is derived from its predecessor, gross profit. Operating profit or operating income takes gross profit and subtracts all overhead, administrative, and operational expenses. Operating expenses include rent, utilities, payroll, employee benefits, and insurance premiums. Operating profit includes all operating costs except interest on debt and the company’s taxes.
Operating profit margin is calculated by taking operating income and dividing it by total revenue. Like gross profit margin, operating profit margin can be expressed as a percentage by multiplying the result by 100 as shown below.
Operating Profit Margin
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begin{aligned} &text{Operating Profit Margin} = frac { text{Operating Income} }{ text{Revenue}} times 100 \ end{aligned} Operating Profit Margin=RevenueOperating Income×100
Comparing Gross Profit Margin and Operating Profit Margin
Below is a portion of the income statement for JC Penney Company Inc. (JCP) as of May 5, 2018.
- Total revenue is highlighted in green for the amount of $2.67 billion while the COGS is beneath revenue coming in at $1.7 billion.
- Gross profit margin was 36% OR
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begin{aligned} frac { $2.67 text{ Billion} – $1.7 text{ Billion COGS} }{ $2.67 text{ Billion} } = .36 times 100 = 36% end{aligned}
$2.67 Billion$2.67 Billion−$1.7 Billion COGS=.36×100=36% - Operating income, which is further down the statement, totaled $3 million for the period and is further down the statement, highlighted in blue.
- Operating profit margin was .11% OR
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begin{aligned} frac { $3 text{ Million} }{ $2.67 text{ Billion} } = .0011 times 100 = .11% end{aligned}
$2.67 Billion$3 Million=.0011×100=.11% - Although JC Penney had a 36% gross profit margin, after taking out operating expenses and overhead, listed as selling, general, and administrative (SG&A), the company earned less than 1% in operating profit margin.
The Bottom Line
JC Penney earned only $3 million in operating income after earning $2.67 billion in revenue. Although gross profit margin appeared healthy at 38%, after taking out expenses and SG&A, operating profit margin tells a different story. The disparity between the numbers shows the importance of using multiple financial metrics in analyzing the profitability of a company.
Gross profit margin (gross margin) and operating profit margin are both used to determine how well a company’s management is generating profits. It’s helpful to compare the profit margins over multiple periods and with companies within the same industry.