The gross margin and the net margin are indicators that are considered essential to better manage your company's activity. They allow you to measure if the activity of a company is profitable.
These indicators make it possible to study the profitability and competitiveness of the company in a given sector. They are used to make informed strategic decisions and are often required when drawing up business plans or financing dossiers for potential investors.
What are gross and net margins? How are these indicators calculated? How to interpret them? We explain everything in this article!
What is the net margin?
Definition
The net margin, also called net profit margin, is the ratio between the company's net income and its sales. This indicator is a rate expressed as a percentage, it is often considered essential in that it evaluates the profit from the business activity, whether it is the sale of goods or services.
How to interpret the net margin?
The net margin shows how much profit is generated for each euro of revenue after interest, operating expenses and taxes. For example, if the net margin rate is 20%, this means that for every euro of revenue generated, 20 cents of net income is generated.
A high net margin reflects the company's ability to better control its expenses and enjoy good profitability. There is no target net margin rate that should ideally be achieved. This indicator is used to situate the company in its sector of activity by comparing its performance with competitors or with the company's previous performance.
How to calculate the net margin?
The net margin is a rate expressed as a percentage. It is determined by dividing net income by sales and multiplying the result by 100 to obtain a percentage:
Net margin = (net income / sales) * 100
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For example, a service provider with a turnover of €500,000 and a net profit of €100,000 has a net margin of 20% {(€100,000 / €500,000) * 100}.
What is the gross margin?
Definition
The gross margin is the difference between the selling price and the cost price of a good or service sold. This indicator is calculated before taxes and is expressed in monetary units.
There is no legal or accounting standard for its definition and gross margin can be interpreted differently depending on the sector of activity. For example, companies selling tangible products are referred to as sales margins.
How to interpret the gross margin?
The gross margin remains a very important indicator for steering the company in that it helps to set the selling price of products and services in order to optimize profitability.
It also gives a good idea of price leverage and can help capture market share by lowering prices while being careful to remain profitable.
Like the net margin, the gross margin is an indicator that allows you to situate the company in its sector of activity by comparing performance with competitors.
Tracking gross margin is also a good way to look at the evolution of the ability to earn profits before taxes and interest.
How to calculate the gross margin?
The gross margin is an indicator expressed in monetary units. It is determined by subtracting the cost price from the selling price of the product or service marketed:
Gross margin = selling price (excluding taxes) - cost of goods sold (excluding taxes)
For example, a merchant with a cost price (excluding tax) of €11.32 on his products, for a selling price (excluding tax) of €34.99, has a gross margin of €23.67. The merchant's gross margin is thus equal to €23.67 per product sold.
Net margin VS gross margin, which one to choose for your company?
The gross margin only reflects profitability in relation to the selling price and the cost of the company's activity, excluding taxes.
While this indicator is very intuitive and provides relevant elements for piloting the company, it is not adapted to complex companies that generate revenues in different ways.
The net margin rate is an indicator of the company's overall performance . The net margin takes into account the operating result, the financial result and the exceptional result.
It also takes into account taxes and interest payments. The performance obtained thus gives a more accurate picture of the company's financial health.
Despite the difference between gross and net margins, both indicators are based on similar levers and provide an idea of the company's profitability.
It can be interesting to consider both: to study the net margin to obtain an overall picture of the company's profitability, and to observe the gross margin in order to analyze profitability in relation to the cost of goods sold and the selling price excluding taxes.
How to improve your margins?
Tips for optimizing margins
High margins do not necessarily give a concrete indication of the danger or imminence of a situation of insolvency and bankruptcy. Indeed, the result and profitability of the company may be based on accounting entries and may be uncorrelated with cash flow receipts.
Although margins do not give an accurate picture of the company's cash position, these indicators do provide important strategic leverage and it is important to analyze and optimize them.
Increase revenues
In order to increase margins, one of the potentially effective levers consists of increasing revenues and therefore increasing the sales prices of the goods and services marketed.
Be careful, however, that this increase is not too abrupt, in which case it could affect the size of your market share.
The only exception is products or services for which the company is in a (quasi)-monopoly situation. In this case, the price increase will have little impact on the number of customers because they have no or few alternatives.
Reduce costs
The other lever, perhaps the most important and least difficult, is to try to minimize operating and other expenses, and to reduce the cost of ownership as much as possible.
It can therefore be advantageous to renegotiate your supplier contractsor to change service providers by using the competition to obtain the best rates.
It is also important to analyze its cost structure to get rid of potential unnecessary expenses, without this being to the detriment of the quality of the products or services marketed.
Karmen and RBF to boost margins
As we have seen, gross and net margins are essential indicators for steering the company. However, they do not provide any concrete analysis of the company's cash position. In order to benefit from the best margin of maneuver to boost margins, is therefore essential .
Karmen is the solution of Revenue Based FinancingKarmen is an innovative financing solution based on the future revenues of project holders. It is a non-dilutive type of financing (there is no transfer of capital in exchange) that allows to secure cash easily and simply in order to optimize margins serenely.
With Karmen, French companies benefit from a 100% non-dilutive, digitalized, and fast financing solution (in less than 48 hours!).
Getting financing with Karmen is easy! Our software connects in read-only mode, thanks to open banking, to your tools to have a quick and efficient view of your company's financial health.
This is enough for us to give you an eligibility answer within 48 hours and offer you the best financing deals, if you are eligible. The amount of financing can be up to 40% of your annual income.
To learn more, please contact our consultants!
Conclusion
Thus, the gross and net margins are essential indicators to study the profitability of the company and to make strategic decisions to better manage the business.
While the net margin provides an overall picture of the company's profitability, the gross margin analyzes profitability based on the cost of goods sold and the selling price excluding taxes.
However, these indicators do not provide an accurate picture of the company's cash flow situation. To optimize these indicators with confidence, it may be worthwhile to use a non-dilutive financing solution like Karmen.
