Margins: Gross, Operating, Net

Introduction

Margins measure how much of each revenue dollar the company keeps at different stages. They reveal efficiency and pricing power. This lesson covers the three key margins.

Gross Margin

Gross margin = Gross profit ÷ Revenue. It shows the profitability of production before operating costs.

Gross margin = (Revenue - COGS) / Revenue

High and stable gross margins suggest strong products and pricing power.

Operating Margin

Operating margin = Operating profit ÷ Revenue. It reflects efficiency in running the whole core business, before interest and tax.

Operating margin = Operating profit / Revenue

It shows how well management controls costs and operates.

Net Margin

Net margin = Net income ÷ Revenue. It's the percentage of revenue that ends up as bottom-line profit.

Net margin = Net income / Revenue

A low net margin can still mean a healthy business if it's asset-light and turns revenue quickly.

Reading Margins

• Rising margins usually mean improving efficiency or pricing power
• Different industries have very different normal margins (software high, retail low)
• Compare a company's margins to its peers and history

A Common Caution

A company with high revenue but razor-thin margins is vulnerable: a small cost increase can wipe out profit. Margin stability matters as much as level.

Real-World Example

A software company has 80% gross margin, 30% operating margin, and 25% net margin — very efficient. A grocery retailer might have 25% gross, 5% operating, and 2% net margin — still viable but with far less room for error.

Summary

• Gross margin: profitability of production
• Operating margin: efficiency of the core business
• Net margin: bottom-line profit per revenue
• Rising margins signal improving efficiency
• Compare margins within the same industry and over time

Next Lesson

Returns on equity and assets — efficiency for owners.