Gross Profit Margin vs. Operating Profit Margin

Gross profit margin and operating profit margin are two metrics used to measure a company’s profitability. Gross profit margin includes the direct costs involved in production, while operating profit margin accounts for operating expenses like overhead.

Both metrics are important in assessing the financial health of a company.

Gross Profit Margin

Gross profit margin shows how well a company generates revenue from direct costs like direct labor and materials used in production. Gross profit is first calculated by subtracting the cost of goods sold from total revenue. Gross profit margin is the difference divided by total revenue and shown as a percentage.

$\begin{aligned} &\text{Gross Profit Margin} = \frac { \text{Revenue} – \text{COGS}}{ \text{Revenue}} \times 100 \\ &\textbf{where:} \\ &\text{COGS} = \text{Cost of goods sold} \\ \end{aligned}$​Gross Profit Margin=RevenueRevenue−COGS​×100where:COGS=Cost of goods sold​

Operating Profit Margin

Operating profit is derived from 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. The operating profit calculation excludes interest on debt and the company’s taxes.

Operating profit margin is calculated by dividing operating income by total revenue. Like gross profit margin, operating profit margin is expressed as a percentage.

$\begin{aligned} &\text{Operating Profit Margin} = \frac { \text{Operating Income} }{ \text{Revenue}} \times 100 \\ \end{aligned}$​Operating Profit Margin=RevenueOperating Income​×100​

Comparing Gross Profit Margin and Operating Profit Margin

Below is a portion of an old income statement for JCPenney. In this example, JCPenney earned only $3 million in operating income after earning $2.67 billion in revenue.

Although the gross profit margin appeared healthy at 38%, after taking out expenses and selling, general, and administrative expenses (SG&A), the operating profit margin tells a different story. The disparity between the numbers shows the importance of using multiple financial metrics in analyzing a company’s profitability.

• Total revenue is highlighted in green as $2.67 billion, while the COGS is beneath revenue, coming in at $1.7 billion.
• Gross profit margin was 36%, or
  $\begin{aligned} \frac { \$2.67 \text{ Billion} – \$1.7 \text{ Billion COGS} }{ \$2.67 \text{ Billion} } = .36 \times 100 = 36\% \end{aligned}$$2.67 Billion$2.67 Billion−$1.7 Billion COGS​=.36×100=36%​
• Operating income, which is further down the statement, totaled $3 million for the period and is further down the statement, highlighted in blue.
• Operating profit margin was 0.11%, or
  $\begin{aligned} \frac { \$3 \text{ Million} }{ \$2.67 \text{ Billion} } = .0011 \times 100 = .11\% \end{aligned}$$2.67 Billion$3 Million​=.0011×100=.11%​
• Although JCPenney had a 36% gross profit margin, after taking out operating expenses and overhead, listed as SG&A, the company earned less than 1% in operating profit margin.

What Expenses Are Included in COGS?

Cost of goods sold (COGS) is the cost to manufacture the products or finished goods that a company sells. Costs included in the measure are directly tied to the production of the products, including the labor, materials, and manufacturing overhead.

What Are Overhead Costs?

Overhead costs include all of the expenses to run a business, like rent, insurance, and utilities.

How Often Do Companies Report Earnings?

The Bottom Line

The gross profit margin can show a company’s financial health. However, when accounting for additional operating costs like rent or payroll, the operating profit margin may be lower than the gross profit margin. The difference between the numbers proves how important it is for investors and analysts to use multiple financial metrics in analyzing a company’s financial position.