Gross profit and net profit both appear on an income statement, but they measure very different things. Confusing the two leads to bad pricing decisions and an inaccurate picture of business health.
Gross Profit
Gross profit is what is left after subtracting the direct cost of producing or delivering what you sold (cost of goods sold, or COGS) from your revenue.
Gross profit = Revenue − Cost of goods sold
COGS includes:
- Materials and components
- Manufacturing labor
- Packaging
- Direct fulfillment costs
COGS does not include rent, salaries for non-production staff, marketing, or administrative costs.
Gross margin expresses this as a percentage of revenue:
Gross margin = Gross profit ÷ Revenue × 100
A product that sells for $100 with $40 in COGS has a gross profit of $60 and a gross margin of 60%.
Net Profit
Net profit (also called net income or "the bottom line") is what is left after all expenses are subtracted, including operating expenses, interest, and taxes.
Net profit = Gross profit − Operating expenses − Interest − Taxes
Operating expenses include salaries, rent, marketing, software, and all other overhead. Net profit is what the business actually earned after everything is paid.
Net margin is net profit as a percentage of revenue:
Net margin = Net profit ÷ Revenue × 100
Why the Difference Matters
A high gross margin does not mean the business is profitable. A SaaS company with 80% gross margins can still lose money if it spends heavily on sales, marketing, and engineering. Gross margin tells you how efficiently you deliver your core product. Net margin tells you whether the whole business model works.
Conversely, a business can have low gross margins and still be highly profitable if operating costs are lean. Grocery stores run gross margins of 20–30% but operate profitably at net margins of 1–3%.
Gross Margin Benchmarks by Industry
Gross margins vary widely by industry:
- Software (SaaS): 60–85%
- Digital products: 70–90%
- Professional services: 50–70%
- E-commerce (product): 30–50%
- Restaurants: 60–70% (before labor and rent)
- Manufacturing: 20–40%
- Grocery / retail: 20–35%
If your gross margin is significantly below your industry benchmark, investigate your COGS structure before addressing other costs.
What Gross Margin Is Used For
Gross margin drives several important business calculations:
LTV in SaaS: Customer lifetime value is often calculated as (ARPU × Gross margin) ÷ Churn rate. A higher gross margin means each customer is worth more in real terms.
Contribution margin analysis: Gross margin tells you how much each sale contributes toward covering fixed costs and generating profit.
Pricing decisions: Raising or lowering prices directly affects gross margin. A price cut that feels small can significantly compress margin if COGS is already a large portion of revenue.
Investor due diligence: Investors in high-growth businesses often focus on gross margin as a measure of the business model's quality, since operating leverage depends on it.