Feb 09 2014 12:15 AM
When a company sells its goods in the market, it makes some money. This money is called the income or revenue.
But as we all know, to sell the goods and make income, every company has to invest some amount initially to buy the raw material and other ingredients that are used directly in making the product. For eg: dough, vegetables, cheese etc in making a Pizza. The amount spent to procure these ingredients which are used in making the final products/ goods is called the Cost of goods sold.
Eg: if we are selling a pizza for Rs.300 and the cost of making it is Rs.100, then our income is 300-100 = 200. This amount of money that is left with us after we spend on ingredients is called the Gross Margin.
Hence, Gross Margin = Revenue (Income from sales) - Cost of Goods sold (amount we spent on ingredients)
NET MARGIN: this is also called the Profit After Tax(PAT). This is the final income/ profit that the company has made from its sales after deducting all its expenses.
The explanation is as under;
The company's cost does not stop with procuring the raw material to make its products. Hence, arriving at the Gross Margin will not show it's true income.
There are several other costs involved like marketing expenses, salaries to the staff, rent etc which have to be borne by the company to run its day-to-day operations. Such costs are called Operating expenses or fixed costs.
Gross Margin- operating expenses = Operating income.
But this is not all, the company also will have certain other expenses like paying taxes to the government and paying interest on the loans it took for the business etc. So, since money is being spent on taxes and interest too, these also should be deducted from its income to arrive at the final income that the company made from its sales.
Hence, Operating income - Taxes & interest = Net income (PAT)
The steps at arriving the Gross & Net income are:
Revenue- Cost of Goods Sold(COGS) = Gross Margin/ income
Gross Margin- Operating Expenses = Operating Income
Operating Income- taxes &interest = Net income
Hope this helps..