Difference Between Gross Profit Margin and Standard Margins

So your business is turning a profit, and it’s a wonderful feeling. But imagine: Someone looks at your sales revenue report, and asks: "What’s this about standard margin? How can it be that your gross margin is great while your standard margin needs work?" Your eyebrows shoot up and you blink at the question he has just asked.

Margin refers to the difference between the selling price of a product and the cost of that product. Margin is expressed as a percentage of the total selling price. Let’s say, that a retail shop owner purchases a product from a wholesaler for $8, but charges customers $10. In this example, the shop owner earns a margin of 20 percent. It is important to note, however, that this marginal figure, also known as gross margin, does not include the cost of advertising or of paying employees. It includes only the cost of manufacturing or purchasing the product.

For another example of gross margin, consider a sports retailer who buys a tennis racket for $100 and sells it for $150. The retailer is earning a $50 profit. This equals 33.3 percent of the total revenue. In other words, this is roughly a 33 cent profit for every $1 in sales. Naturally, gross profit margin must always be greater than expenses.

Standard margin is a bit more involved. Standard margin is the amount, or balance, remaining from profit after deducting the costs incurred in obtaining the sale. Costs may include paying staff, paying commissions to sales people, advertising, utility bills, phone bills, and insurance. Note that standard costs are usually fixed—they occur at regular intervals and are budgeted for. Rent or property taxes are also standard costs. By definition, standard margin cannot account for irregular or unpredictable business costs.

Both gross margin and standard margin are essential for measuring the health of a business, but they look at different aspects of the financial situation. Gross margin is useful for looking at overall revenue. This is akin to a bird’s eye view. However, if you look only at gross margin, you can come away with a rather rosy view of the company.

It is possible for a company to have a stellar gross margin, but a scary standard margin, and by now, you’ve probably guessed why. Standard margin can reveal that a company has unsustainable monthly expenses—whether stemming from payroll, rent, or advertising budget.

For instance, if a company spends $100,000 on products and sells them all for $150,000 they’ve generated $50,000 in gross profit. But if that same company had $45,000 in expenses that month, they have a standard margin of only $5,000.

Changes in price over time can affect gross margin, which will, in turn, impact standard margin. For instance, if prices go up but the cost of the product stays the same, gross margin will increase. This will, of course, affect standard margin, if monthly expenses remain the same. But if monthly expenses increase at the same time, then they will eat into that windfall and the standard margin will reflect this. Naturally, you want to maintain or improve your gross profit margin over the life of your business. If your gross margin slips, you may be headed for trouble.

It’s crucial to understand that markup percentage and gross margin are not the same thing. Markup percentage is the difference—in percentage—between the cost of a product and its selling price. Gross margin, on the other hand, is the percentage difference between the selling price and the profit.

While markup is often used by sales departments to set prices, it can provide a skewed picture of profitability. The markup will always be a bigger number than gross margin. Markup percentage is most often expressed as a percentage of the cost. Consider the following:

• 100 percent markup equates to 50 percent gross profit

• 50 percent markup equates to a 33 percent gross profit.

• 25 percent markup equates to a 20 percent gross profit.

Now that you’re clear on these differences, should you look at gross margin or standard margin? The simple solution is to utilize both. Gross profit margin provides you with a overhead view and standard profit margin can illuminate areas in need of improvement. Indeed, scrutinizing standard margin can force you to look for ways to lower your regular expenses. Then, all you need to do is decide what to do with the recouped profits.