Gross profit vs net profit: formulas and margins

The short answer

Gross profit is revenue minus the cost of the goods or services sold. Net profit is what remains after every expense has been deducted: cost of sales, operating expenses, finance costs and income tax. Gross profit shows whether the product itself makes money; net profit shows whether the whole business does. It matters because a healthy gross profit can still end in a net loss if overheads are too high.

Both figures appear on the income statement, also called the statement of profit or loss. Gross profit is near the top, directly below revenue and cost of sales. Net profit, also called profit for the year, net income or the bottom line, is the last line before any split between owners of the parent and non-controlling interests.

• Gross profit = revenue - cost of sales
• Gross profit margin = gross profit divided by revenue
• Operating profit = gross profit - operating expenses (+ other operating income)
• Net profit = operating profit - finance costs + finance income - income tax
• Net profit margin = net profit divided by revenue

A worked income statement in EUR

A homeware retailer reports revenue of EUR 500,000 for the year, net of VAT, returns and discounts. Its cost of sales is EUR 300,000, so gross profit is EUR 200,000 and the gross profit margin is 40 percent. Operating expenses total EUR 150,000, made up of staff 80,000, rent 30,000, marketing 15,000, depreciation 10,000 and other administration 15,000. Operating profit is therefore EUR 50,000, a 10 percent operating margin.

Finance costs on a bank loan are EUR 8,000, giving profit before tax of EUR 42,000. Income tax at an assumed 25 percent is EUR 10,500, so net profit is EUR 31,500 and the net profit margin is 6.3 percent. Of every EUR 100 of sales, EUR 60 pays for the goods, EUR 30 pays for running the shop, EUR 1.60 pays the bank, EUR 2.10 goes in tax and EUR 6.30 is left for the owners.

• Revenue: 500,000 (100 percent)
• Cost of sales: 300,000 (60 percent)
• Gross profit: 200,000 (40 percent)
• Operating expenses: 150,000 (30 percent)
• Operating profit: 50,000 (10 percent)
• Finance costs: 8,000; profit before tax: 42,000 (8.4 percent)
• Income tax: 10,500; net profit: 31,500 (6.3 percent)

What goes into cost of sales

Gross profit is only as reliable as the cost of sales figure beneath it. For a trading business, cost of sales is opening inventory plus purchases minus closing inventory. For the retailer: opening inventory EUR 40,000, plus purchases EUR 310,000, minus closing inventory EUR 50,000, gives EUR 300,000. Under IAS 2 Inventories, the cost of inventory includes the purchase price, import duties and non-recoverable taxes, and transport and handling to bring the goods to their present location, less trade discounts and rebates.

For a manufacturer, cost of sales also carries direct labour and a systematic allocation of production overheads. For a service business such as a consultancy or agency, cost of sales usually means the salaries and subcontractor costs of the people delivering the work. Selling costs, administration, storage after purchase (unless needed in production) and abnormal waste are not part of inventory cost, so they sit below gross profit.

Inventory write-downs to net realisable value are recognised as an expense when they occur, normally within cost of sales. The costing method matters too: in a period of rising prices, FIFO gives a lower cost of sales and higher gross profit than weighted average cost. See our guide on inventory costing for the full comparison.

Markup vs margin

Markup and margin describe the same profit from different bases, and confusing them is one of the most common pricing mistakes. Markup is profit as a percentage of cost; margin is profit as a percentage of selling price. An item that costs EUR 60 and sells for EUR 100 has a profit of EUR 40, which is a 40 percent margin but a 66.7 percent markup.

To convert, use margin = markup divided by (1 + markup), and markup = margin divided by (1 - margin). A 25 percent markup gives a 20 percent margin; a 50 percent markup gives a 33.3 percent margin; a 100 percent markup gives a 50 percent margin. A buyer who is told to achieve a 40 percent margin and applies a 40 percent markup instead will price a EUR 60 item at EUR 84, earning a margin of only 28.6 percent.

• Markup 25 percent = margin 20 percent
• Markup 50 percent = margin 33.3 percent
• Markup 66.7 percent = margin 40 percent
• Markup 100 percent = margin 50 percent
• Price to achieve a target margin = cost divided by (1 - target margin), for example 60 divided by 0.6 = 100

What moves gross profit

Gross profit responds to anything that changes the relationship between what customers pay and what the goods cost. Because operating expenses are largely fixed in the short term, every euro of gross profit gained or lost usually flows straight to operating profit.

Worked sensitivity: if the retailer's supplier raises prices by 4 percent and the increase cannot be passed on, cost of sales rises from EUR 300,000 to EUR 312,000. Gross profit falls to EUR 188,000 and the margin to 37.6 percent. Operating profit falls from EUR 50,000 to EUR 38,000, a drop of 24 percent. A 4 percent cost change became a 24 percent profit change, which is why buyers watch gross margin weekly.

The lever works in the other direction too. If the retailer instead raises prices by 5 percent and sells the same volume, revenue becomes EUR 525,000 while cost of sales stays at EUR 300,000. Gross profit rises to EUR 225,000, a 42.9 percent margin, and operating profit rises from EUR 50,000 to EUR 75,000, an increase of 50 percent. In practice some volume is usually lost when prices rise, so test the break-even volume before acting.

• Selling prices, discounts, promotions and rebates to customers.
• Purchase prices, supplier rebates, freight-in and import duties.
• Sales mix: selling more low-margin lines lowers the average margin even if every line's margin is unchanged.
• Shrinkage, damage and theft, which show up as inventory losses.
• Inventory write-downs for obsolete or slow-moving stock.
• Cut-off errors: sales recorded without the matching cost, or purchases in the wrong period.
• Classification choices, such as whether warehouse wages sit in cost of sales or operating expenses.

What moves net profit

Net profit inherits every change in gross profit and adds three more layers: operating expenses, financing and tax. Operating expenses include salaries outside production, rent, marketing, depreciation of non-production assets, professional fees, IT and insurance. Finance costs depend on borrowing and interest rates, and on lease interest under IFRS 16. Income tax depends on the tax rate, tax deductions and deferred tax.

One-off items also land in net profit: a gain on selling a property, an impairment of goodwill, a restructuring cost or a large legal settlement. That is why analysts compare net profit with operating profit and with the previous year before drawing conclusions. A net profit that jumps because of a one-off gain says nothing about whether the shop trades better.

Net profit is also not cash. Credit sales, inventory build-ups, capital expenditure and loan repayments all separate profit from the bank balance, which our guide on cash flow versus profit explains.

Gross profit and net profit under IFRS

IFRS does not require every company to show gross profit. Under IAS 1, and under IFRS 18 Presentation and Disclosure in Financial Statements, which replaces IAS 1 for annual periods beginning on or after 1 January 2027, a company classifies operating expenses either by function (cost of sales, distribution, administrative) or by nature (raw materials, employee benefits, depreciation). Gross profit appears naturally when expenses are presented by function; a company presenting by nature may not show it at all. IFRS 18 lists gross profit among the subtotals that are not management-defined performance measures.

IFRS 18 also makes operating profit a required subtotal, together with profit before financing and income taxes. From 2027, therefore, an IFRS reporter's income statement will show revenue, a required operating profit, profit before financing and income taxes, and profit for the year, whether or not it shows gross profit. Net profit remains the profit or loss for the period, the total that is closed to retained earnings at the end of the year.

Common mistakes when comparing margins

Margins are only comparable when they are measured the same way. These errors produce misleading comparisons between periods, branches or competitors.

• Mixing VAT-inclusive sales with VAT-exclusive costs.
• Comparing a company that puts delivery costs in cost of sales with one that puts them in distribution expenses.
• Judging a retailer's net margin against a software company's net margin.
• Reading gross margin for a month with a large inventory adjustment without separating the adjustment.
• Averaging margin percentages across products instead of dividing total gross profit by total revenue.
• Using markup figures from a price list as if they were margins.

Tracking gross and net profit in Skyline Nexus ERP

In Skyline Nexus ERP the ledger income statement is Fiscal Authority, Reports, Income Statement (page title Profit & Loss). It shows Revenue, Cost of Goods Sold, Gross Profit, Operating Expenses, Operating Income, Other Income, Other Expenses and Net Income with a percentage of revenue column, so gross and net margin are read directly. It can be compared with the previous period or previous year and filtered by project and by location or branch. The core Reports menu also has an operational Profit & Loss built from documents, which is a trading report rather than the general ledger statement.

Gross profit by product line depends on account mapping. Product categories can carry their own GL Sales Account and GL COGS/Purchase Account, and a sale's revenue and cost of goods sold are split by category when these are set. Cost of sales is driven by the Stock Accounting Method in Business Settings, which offers FIFO or LIFO; FIFO is the IFRS-compatible choice, as IAS 2 does not permit LIFO.

Checklist before you trust a margin

Run these checks before presenting gross or net margin to management, a lender or a buyer.

• Revenue is net of VAT, returns, discounts and rebates.
• Inventory has been counted or reconciled and closing stock is valued at the lower of cost and net realisable value.
• Purchases and sales are cut off in the same period.
• Cost of sales includes freight-in and duties consistently.
• One-off items are identified separately in the commentary.
• Related guides: financial ratio analysis, unit economics and break-even, and what is EBITDA.