Run it with less chaos · Every business
Gross Margin vs. Net Profit, Explained for Owners
Gross margin tells you whether the work itself is priced well, and net profit tells you whether the whole business is, so an owner needs both numbers to know which one to fix.
Gross margin is the share of revenue left after the direct costs of doing the work, such as materials, supplies, subcontractors and, in many service businesses, the wages of the people delivering it. Net profit is what remains after every other expense is paid as well, including rent, the office, software, insurance, marketing, vehicles, interest and the owner's own pay if it runs through the business.
The two formulas, side by side
| Gross margin | Net profit margin | |
|---|---|---|
| Formula | (Revenue − direct costs) ÷ revenue | (Revenue − all expenses) ÷ revenue |
| What it subtracts | Materials, supplies, subs, labor on the job | Everything: direct costs plus overhead, interest and taxes as you define them |
| Where it sits on a sole proprietor's tax form | Schedule C, line 5, "Gross profit" | Schedule C, line 31, "Net profit or (loss)" |
| What it answers | Is each job priced to cover its own costs with room to spare? | Is the business as a whole earning money? |
| What to change when it is low | Prices, job mix, materials waste, hours per job | Overhead, capacity use, or gross margin if overhead is already lean |
On the IRS Schedule C, line 1 is gross receipts, line 4 is cost of goods sold and line 5 is gross profit, while line 31 is net profit or loss after the expenses on lines 8 through 30. Many service businesses report little or no cost of goods sold on the form, so for management purposes it helps to count the labor and materials that go into each job as direct costs, even when the tax form does not.
Your one-page check (copy this)
- Take last year's or last quarter's revenue from your books.
- Add up direct costs: materials, supplies, subcontractors and wages plus payroll costs for the people who deliver the work.
- Gross margin = (revenue − direct costs) ÷ revenue.
- Add up everything else: rent, utilities, office staff, software, insurance, marketing, vehicles, interest and owner's pay.
- Net profit margin = (revenue − direct costs − everything else) ÷ revenue.
- Write both numbers on one line and compare them with the same period a year ago.
Why it works
Separating the two numbers tells you where the problem lives. The average remodeler in the NAHB study kept 29.9 cents of gross margin from every dollar and spent 23.6 cents of it on operating expenses, so a business with a healthy gross margin and a thin net profit has an overhead or capacity problem, while one with a thin gross margin has a pricing or job-cost problem that cutting overhead alone will not fix.
General information, not legal/tax/financial advice; talk to a licensed professional about your situation.
Sources
- Internal Revenue Service. Schedule C (Form 1040), Profit or Loss From Business. Tax year 2025.
- National Association of Home Builders. Remodelers Saw Profit Margin Gains in 2024. Eye on Housing, April 2026.
Related reading: How to Calculate Profit Per Service in Five Minutes · Revenue Isn't Profit: Why Growing Businesses Run Out of Cash · Job Costing for Contractors Who Hate Spreadsheets
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