Gross Margin vs Net Margin
Gross margin measures the share of revenue left after the cost of producing or delivering what a company sells. Net margin measures the share that reaches net income after the rest of the income statement, including operating expenses, non-operating items and taxes.
The difference matters most when the two move in opposite directions. In Microsoft’s fiscal 2026 results, gross margin declined from 68.8% to 67.9%, while net margin increased from 36.1% to 40.3%. Those figures are not contradictory. They describe different layers of the same business.
For an investor, the useful question is not which margin looks more impressive. It is what happened between revenue and the bottom line, and whether that explanation supports your view of the company.
Gross and net margins measure different layers
Both ratios use revenue as the denominator. What changes is the profit figure above it.
Gross margin = (Revenue – Cost of revenue) / Revenue x 100
Net margin = Net income / Revenue x 100
Gross profit is a dollar amount; gross margin usually means that amount expressed as a percentage of revenue. Some companies use “gross margin” as the label for the dollar subtotal too. Check the units rather than assuming every figure with that label is a percentage.
| Measure | Profit divided by revenue | Main question it helps answer |
|---|---|---|
| Gross margin | Gross profit | How much revenue remains after the reported costs of goods or services sold? |
| Operating margin | Operating income | How much remains after operating expenses such as research, selling and administration? |
| Net margin | Net income | What share reaches the bottom line after non-operating items and taxes as well? |
Operating margin is the useful middle step. Without it, a change in net margin can blur together the economics of running the business, its financing costs, investment results and tax position.
Use gross margin to investigate selling prices, product mix and delivery costs. Use operating margin to include the wider cost of running the business. Use net margin when the question concerns the complete reported earnings outcome. Net margin is more comprehensive, but that does not make it the better answer to every question.
Operating margin = Operating income / Revenue x 100
The SEC’s guide to financial statements explains this progression through the income statement. Unlike a balance sheet, which reports a position at a date, these profit figures cover a period. Our comparison of the income statement and balance sheet explains why that distinction matters when combining financial data.
Cost of revenue may be called cost of sales or cost of goods sold. It is not limited to raw materials: a service business also incurs costs to deliver its offering. Exactly which costs sit above or below gross profit depends on the business and its accounting presentation. Depreciation can already be included in cost of revenue or operating expenses; it is not automatically another expense to subtract afterward.
Gross margin is not a pure measure of variable costs either. For example, IAS 2’s inventory-cost guidance includes allocated fixed production overhead. A reported gross-margin percentage therefore does not, by itself, tell you the profit from making one additional sale.
Two other labels can cause confusion. Net sales generally means sales after items such as returns and allowances, not profit after all expenses. Markup divides gross profit by cost, whereas gross margin divides it by revenue. The two percentages are not interchangeable.
Microsoft: from revenue to net income
The following example uses Microsoft’s consolidated income statements prepared under US generally accepted accounting principles (GAAP) for the years ended June 30, 2026 and June 30, 2025. Sources were reviewed on November 2, 2026. This is an annual comparison, not a trailing-twelve-month calculation or a description of the latest quarter.
All dollar figures below are USD millions, from the income statements in Microsoft’s FY2026 Form 10-K. The operating-expense subtotal adds research and development, sales and marketing, and general and administrative expenses.
| Income-statement item | FY2026 | FY2025 |
|---|---|---|
| Revenue | 331,839 | 281,724 |
| Cost of revenue | 106,374 | 87,831 |
| Gross profit | 225,465 | 193,893 |
| Operating expenses | 70,228 | 65,365 |
| Operating income | 155,237 | 128,528 |
| Other income (expense), net | 10,697 | (4,901) |
| Income before income taxes | 165,934 | 123,627 |
| Provision for income taxes | 32,185 | 21,795 |
| Net income | 133,749 | 101,832 |
Microsoft labels the gross-profit dollar subtotal “Gross margin.” Here, gross profit means that dollar amount, and gross margin means the percentage we calculate from it. Parentheses indicate a negative amount, so FY2025’s other expense reduces profit rather than adding to it.
For FY2026, the first calculation is:
Gross margin = 225,465 / 331,839 x 100 = 67.9%
The net-margin calculation uses the same revenue denominator:
Net margin = 133,749 / 331,839 x 100 = 40.3%
Applying the same method to both years gives:
| Calculated margin | FY2026 | FY2025 | Change |
|---|---|---|---|
| Gross margin | 67.9% | 68.8% | -0.9 percentage points |
| Operating margin | 46.8% | 45.6% | +1.2 percentage points |
| Net margin | 40.3% | 36.1% | +4.2 percentage points |
These are our calculations from the reported amounts, rounded to one decimal place. Changes are calculated before rounding. A percentage-point change is the difference between two percentages, not the relative growth rate of the underlying profit.
The gross-to-net calculation also reconciles in dollars:
225,465 – 70,228 + 10,697 – 32,185 = 133,749
Start with gross profit, subtract operating expenses, add the net other-income amount, then subtract the tax provision. That is how this statement reaches net income. The exact presentation can differ at another company, so follow its reported lines instead of forcing this layout onto every issuer.
For each dollar of revenue, Microsoft reported roughly 68 cents of gross profit and 40 cents of net income in FY2026. That description concerns accounting profit, not cash available for distribution. The distinction becomes important when considering the spending needed to sustain or expand the business.
Why Microsoft’s margins moved in different directions
There are three changes to separate. Combining them into a single statement that “profitability improved” would lose information an investor needs.
Gross profit grew, but its share of revenue fell
Gross profit increased by $31,572 million, or 16.3%. Revenue increased faster, by 17.8%. As a result, the business generated more gross-profit dollars but retained a slightly smaller share of each revenue dollar at that stage.
This is a denominator effect worth recognizing: a falling margin does not necessarily mean shrinking profit. Conversely, a rising margin does not guarantee growing profit if revenue falls enough.
Microsoft’s annual-report discussion attributes the gross-margin percentage pressure to AI infrastructure investment and growing AI usage, partly offset by cloud efficiencies. That is management’s explanation of the change. The arithmetic establishes the decline; it does not independently establish the future returns from that investment.
Nor should this explanation be read as saying that all infrastructure spending immediately becomes an income-statement expense. Asset purchases and the expenses recognized as those assets are used follow different accounting timing.
Operating expenses grew more slowly than revenue
Operating expenses increased from $65,365 million to $70,228 million, a rise of 7.4%. They did not fall in dollars. But as a share of revenue, they declined from 23.2% to 21.2%.
That lower expense share more than offset the reduction in gross margin, allowing operating margin to rise from 45.6% to 46.8%. This is a concrete example of operating leverage: revenue growth outpaced growth in the expenses deducted after gross profit.
It would be inaccurate to describe the result simply as cost cutting. Operating expenses rose, while revenue grew faster. It would also be premature to assume the same relationship will continue. A subsequent increase in hiring, research or sales spending could change it.
The lower overall expense share does not prove that every individual cost became more efficient. It describes the relationship between total operating expenses and revenue; assessing the results of specific spending requires more detail.
Non-operating items also affected the bottom line
Other income and expense swung from a net expense of $4,901 million to net other income of $10,697 million. That $15,598 million improvement helped net income beyond the increase in operating profit.
The annual report discloses gains from OpenAI investments within this line, versus losses in the prior year. Those investment results are not revenue from selling Microsoft’s products and services, and they do not account for the entire other-income line. They are a reason to examine the composition of net income rather than assuming that its growth came entirely from operations.
An investment gain can be real and properly included in reported earnings without indicating stronger customer demand. Recognizing it is different from assuming it will recur. Keep that distinction when deciding what the net-margin improvement tells you about the ongoing business.
Meanwhile, the tax provision increased by $10,390 million, offsetting part of the improvement in pretax earnings. In dollars, the full change reconciles as follows:
26,709 higher operating income + 15,598 improvement in other income – 10,390 higher tax provision = 31,917 higher net income.
This explains the change in reported net-income dollars. It is not a forecast, an adjusted-profit calculation or a claim that each component will recur. It also shows why the net-margin increase should not be attributed solely to stronger operating economics.
The dollar increase is not a margin change: net margin also depends on revenue, which grew during the same period. Use the margin table to compare percentages and the dollar reconciliation to understand how the reported profit changed.
A wide gap is a question, not a verdict
Microsoft’s FY2026 gross and net margins differ by approximately 27.6 percentage points. That gap captures the net effect of operating expenses, other income and expense, and the tax provision relative to revenue. Calling the entire amount “overhead” or “waste” would misdescribe it.
Research spending may support future products. Sales spending may help win customers. Administration includes necessary costs of running a company. Those expenditures still need scrutiny, but a large amount is not itself evidence of poor management, just as calling something an investment does not prove it will pay off.
When evaluating business quality, use the gap to locate questions. If selling expenses absorb more of revenue, look for evidence about customer acquisition and retention. If interest expense is the main pressure, investigate financing and debt. If a tax benefit lifts net income, distinguish that benefit from changes in operating performance.
The location of the change matters. A company with positive gross profit can still report a net loss because the remaining expenses exceed it. That does not erase the gross profit, but it does mean the business has not converted it into positive bottom-line earnings for that period.
The reverse exception matters too: net margin can exceed gross margin if sufficiently large non-operating gains or tax benefits lift net income above gross profit. Do not automatically label that a data error, but do investigate it. It is not evidence that selling activities produced the entire profit.
There is no universal gross or net margin that makes a stock attractive. A higher gross margin may reflect pricing power, product mix, lower delivery costs or differences in cost classification. A lower-margin business may operate with different asset needs and sales volumes. Margin percentages alone do not resolve those differences.
This is also the appropriate role for margins within StockGeniuses’ broader Core Metrics and business-quality analysis: useful evidence about the business, considered alongside other measures, rather than a standalone recommendation. Neither margin tells you what price to pay for the shares.
Make the comparison consistent
A correct formula can still produce a misleading comparison when the inputs describe different things. Before comparing companies or periods, check the following boundaries.
Keep the period and scope matched. Divide annual profit by that year’s revenue, or quarterly profit by the same quarter’s revenue. Use a consistent consolidated scope. If a data provider uses income attributable to the parent rather than total consolidated net income, identify that definition before comparing it with another provider’s figure.
For a trailing-twelve-month margin, sum the matching four quarters of profit and revenue, then divide. Do not take a simple average of quarterly margin percentages: a low-revenue quarter should not receive the same weight as a high-revenue quarter. Also avoid mixing year-to-date and standalone-quarter figures, which can count the same months twice.
Keep the accounting basis visible. A reported gross margin and an adjusted net margin may exclude different costs. The resulting gap is no longer a straightforward reconciliation through the reported income statement. Inspect the exclusions and their tax effects before treating it as one.
The GAAP versus non-GAAP earnings comparison explains how to assess those adjustments. In particular, do not subtract a pretax gain directly from after-tax net income to produce an allegedly normalized margin. This Microsoft example retains reported GAAP results throughout; it does not calculate a preferred version of earnings.
Compare businesses with relevant economics. Start with the company’s own history, then examine peers with reasonably similar products, revenue recognition and cost presentation. A software provider and a retailer need not have similar margins to be viable businesses. Within a diversified company, changes in the mix of segments can move the consolidated margin even when no individual segment’s pricing changes.
Even close competitors can have different debt costs and tax positions. Comparing operating margins alongside net margins helps separate those differences from operating performance. It does not make financing costs or taxes irrelevant; it shows where they enter the comparison.
Read the accounting notes when a gap seems unusually large. Two issuers may classify fulfillment, support or other costs differently. A difference at gross profit may partly disappear at operating income. Where a company does not report a comparable cost-of-revenue subtotal, do not manufacture one from an unrelated expense line just to complete a peer table.
Do not turn profit into cash by changing the label. Net income includes accrual accounting: revenue recognition, expense recognition and cash collection or payment need not occur together. Capital expenditure generally is not deducted in full from net income when paid, while depreciation may already reduce profit over time. Debt principal repayments are another cash use that is not an ordinary income-statement expense.
A strong net margin therefore does not establish strong cash generation after investment, or the ability to fund every obligation. Compare free cash flow versus net income when that is the question. A tax provision is likewise not a direct measure of cash taxes paid during the same period.
Finally, a margin requires a meaningful revenue denominator. With zero revenue it is undefined, and with very small revenue it can become extreme. Negative net income with positive revenue produces a negative net margin; do not replace that result with zero or treat the absence of a positive margin as missing data.
Read the margins together
Gross margin helps you inspect the economics represented by revenue and cost of revenue. Net margin shows the final accounting outcome. Operating margin connects them by separating operating performance from what happens below it.
Microsoft’s annual comparison illustrates why all three matter: gross margin declined, operating expenses absorbed less of revenue, and non-operating results helped lift the bottom line. Choosing only the gross or net figure would tell an incomplete story.
When margins diverge, follow the intervening lines. Explain which change came from operations, which came from financing, investments or taxes, and which still needs investigation. A margin becomes useful when you can explain what produced it, not merely when its percentage looks appealing.
This article is educational. Microsoft is a dated analytical example, not a recommendation to buy or sell its shares.