At a glance, two metrics that can be used to evaluate a firms' profitability, these are:

  1. Gross Profit and Margin
  2. Operating Profit and Margin
  3. Net Profit and Margin (Bonus)

Before going into the details on how each one is calculated, the difference between the two is that gross profit margin only takes into account direct costs, while operating profit margin takes into account operating costs. Both metrics provide an instant view of financial health of a firm. 

We’re going to use Microsoft’s (MSFT) 2021 income statement to calculate these margins and see how profitable they are. In Q2 2021, here’s a snippet of Microsoft’s income statement (Source here)


Gross Profit Margin:  

Gross margin profits show the strength of a firm to generate revenue against the money it spent on direct costs like labor and materials. Starting from the top of the Income sheet, MSFT reported Total Revenue of $46,152B. It cost MSFT $13,991 to build the products and sell them, also referred to as Cost of Goods sold (COGS). Subtracting the COGS from Revenue, gives the gross profit.  

Gross Profit = Total Revenue – COGS = $46,152 - $13,991 = $32,161 

Gross Profit Margin = (Total Revenue – COGS/Total Revenue) x 100 = ($32,161/$46,152) = ~70% of Gross profit Margin. 

70% is a very healthy margin and highlights the strength of MSFT to generate high profits, while managing product/services related direct costs. 

Operating Profit Margin: 

Sticking with MSFT example, below the Gross profit, is a list of operating expenses that MSFT has to pay for its operations. Also known as Earnings before Interest and Taxes (EBIT), Operating profit is calculated by subtracting the Operating Income from the Total Revenue 

Operating Profit = Total Revenue – Operating Income = $46,152 - $19,100 = $27,052 

Operating Profit Margin = (Total Revenue – Operating Income/Total Revenue) x 100 = ($27,052/$46,152) = ~59% of Operating profit Margin. 

59% is a very healthy margin and highlights the strength of MSFT to keep operating costs low. 
Both Gross profit margin and Operating profit margin are good indicators of a firms’ financial strength at a high level. Neither take into account interest and taxes a firm owes.

Bonus: Net Profit margin: 

If one is to go deeper down the rabbit hole by taking interest and taxes into consideration, Net profit and Net profit margin will be the all-inclusive metric, highlighting financial strength of the firm. The higher this number, the more profitable a firm. In MSFT’s case, they made 35% in profit margin or .35 cents on every $1 dollar of revenue generated.