Gross Profit vs. Gross Margin: Measuring What Matters

If you’re a growing business with goals to innovate and scale while remaining profitable, it’s crucial that you know how to make sense of your financial data. By doing so, you can ensure you’re getting a comprehensive view of your business performance, rather than just staring at an overwhelming assortment of numbers.

But when it comes to assessing profitability, it can be hard to figure out which types of metrics are most useful, or which most accurately represent the state of your business’s financial health. 

Among the most commonly used profitability metrics are gross profit vs. gross margin, though many still conflate the two—or make the mistake of using the terms interchangeably.

The Importance of Monitoring Financial Performance Accurately

Revenue growth is what every company strives for, especially in the short term or when they’re first starting to scale. But eventually, all businesses see a slowdown in growth after the peak of their acceleration. At that point, profitability becomes the most crucial goal, as it’s the most impactful indicator of a business’s lasting success.

But because you can make a profit without guaranteeing profitability, it’s essential to understand the financial metrics that can help you paint the clearest picture possible of your business efficiency, productivity, and growth potential.

Gross Profit vs. Gross Margin: Which is Best for Assessing Your Financial Health?

While both gross profit and gross margin are metrics that help provide insight into a company’s profitability and cost management, they tell distinct and unique stories about how your company is performing (including against others in your industry for competitive analysis). Because of this, it’s important to know how gross profit vs. gross margin differ, and how you can speak to these metrics when assessing and sharing insights on the trajectory of your organization’s sustainable growth.

On one hand, gross profit measures how well a company generates profit from its labor and direct materials. Some of the costs include:

• Cost of direct materials (or cost of goods sold)
• Cost of sales
• Direct labor
• Equipment costs involved in production
• Utilities for the production facility
• Shipping costs

Using gross margin, on the other hand, a business can determine how much it costs to deliver its products or services and how much revenue is coming in. Not to be confused with net profit margin, it exists to answer the key question: How much capital am I retaining per sales dollar spent? In short, gross margin expresses gross profit as a percentage of revenue. 

Watching trends in gross margin can highlight potential problems in your supply chain or customer retention processes—and even help set pricing strategies. Note, however, that when assessing gross profit vs. gross margin, neither metric offers a true, thorough measurement of profitability. This is due to the fact that they don’t take into account operating expenses, interest, and taxes.

Why Gross Margin is One of Your Most Critical Profitability Metrics

Today’s business leaders often turn to profitability metrics to identify company strengths, weaknesses, and targets for organization-wide objectives. In particular, gross margin can identify potential problems before they hurt the bottom line.  

Because profit margin more accurately reflects long-term profitability and a business’s vulnerability to increases in fixed costs (such as expenses and taxes), it’s important to track profit margin and implement strategies that keep it as high as possible. (For reference, in Q4 2023, technology’s profitability margin was 54%. For cloud software, it was 77%.)

Just remember: the higher the gross margin, the better position your company is in to ensure staying power.

How to Calculate the Value of Business Efficiency (+ Examples)

With visibility into and a clear understanding of key profitability metrics, like gross profit vs. gross margin, businesses are empowered to identify areas for improvement and cost efficiency—and take appropriate action—as they navigate the path toward transformative data-centricity.

Measuring profitability can help you maximize gains and minimize margin leakage across your processes. For example, if gross profit decreases because your shipping costs unexpectedly go up, you could consider switching to a cheaper shipping service or reducing the weight of your product packaging. Calculating these metrics can also help you gauge your cash flow runway, and get a sense of what kind of budget you can invest in continuing to grow your business. Think: hiring additional resources, paying down debt, or investing in tools to help scale for the future.

If you’re serious about digging into gross margin metrics, finding key patterns in your data, and identifying margin drivers, you need Cavallo Profit Analytics™. Powered by AI and machine learning and equipped with pre-built data visualizations out-of-the-box, Profit Analytics makes margin analysis intuitive and immediate.

With this robust tool in hand, product-centric companies will:

• Clearly identify margin drivers and profit drains
• Instantly locate the information that matters most in the vast sea of historical ERP data
• Discover the “why” behind margin leakage 
• Gain critical profit-saving insights

This means never missing a beat on strategic spend, sustainable growth, or data-informed decisioning for your organization—plus insight into your competitive standing in the market. An Order Intelligence platform can support you as you get ready to identify key margin trends and patterns in your vast data. Talk to a profit expert today.