Gross Margin, Net Margin, Contribution Margin?

As managers, we often hear and use these terms but just as often, I hear them used incorrectly.  
An executive asks, “What’s our margin on that product?”
“Its profit margin is 62% “, replies the manager incorrectly.
Why is the term “Profit margin” incorrect, what is it that causes the confusion in the use of these terms and, what’s the difference?  The confusion is caused in that while all express profit as a percentage of revenue, the definition of profit is different for each.  Our ready reference chart can help.
 
The key difference between Contribution Margin and the two others is that Contribution Margin is used to look at the profitability of an individual or group of products while Gross and Net Margins are used to evaluate a company’s profitability with all products included.  Contribution margin evaluates products while the others evaluate companies. 
We use contribution margin to:

• Establish or compare products’ profitability.
• Breakeven analysis (how much of the product we must sell to cover its expenses),
• Establish a sales volume mix.

The difference between Gross and Net Margins also lies in the definition of profit.  Gross margin is the remaining profit after subtracting cost of goods sold from revenue where cost of goods sold is the expenses directly related to the manufacture and sale of the products.  Net margin is gross margin minus operating expenses.  Operating expenses include items such as rent, utilities and other overhead expenses not directly driven and related to creating and selling the product.  Net Margin is a better overall indicator of a company’s profitability and the difference between Gross and Net Margins can be an indicator of the operating efficiency of the company.
These are often expressed as a percentage simply by multiplying each margin by 100 and of course, more is better; a larger percent means more remaining money (mullah, dinero, profit, the green stuff…) after having paid expenses.
So, when an executive asks, “What’s our margin on this product?” or, “What is their margin on that product?”, a savvy manager responds, “The product’s Contribution Margin is ….” And when asked to evaluate a competitor, customer, or supplier company, the manager responds using Gross and/or Net margin.
You can watch FREE videos explaining each of these further, complete with examples on how to use them at any time on our YouTube channel.

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