What is gross margin?
Gross margin is gross profit divided by sales, expressed as a percentage, showing how much of each pound of revenue is left after direct costs.
What gross margin means
Gross margin measures how profitable your products or services are before any running costs. It takes gross profit, which is sales less cost of goods sold, and divides it by sales.
Gross margin = (revenue − cost of sales) ÷ revenue × 100
A 45% gross margin means 45p of every £1 of sales is left to pay overheads and provide profit.
Example
An online homeware shop sells a lamp for £50 excluding VAT. It pays the supplier £20, plus £4 for packaging and delivery and £1.50 in payment fees.
| Per lamp | |
|---|---|
| Selling price (ex VAT) | £50.00 |
| Cost of sales | £25.50 |
| Gross profit | £24.50 |
| Gross margin | 49% |
If the shop runs a 20% off sale, the price drops to £40 but the costs stay at £25.50. Gross profit falls to £14.50 and the margin to 36%. It would need to sell about 69% more lamps just to earn the same gross profit.
Why it matters for your business
Gross margin is the first test of a business model. If it is too thin, no amount of cost-cutting on overheads will make the business profitable. It also shows quickly when supplier prices have risen or discounting has gone too far. Tracking it by product line or service in your management accounts often reveals that some lines are carrying others.
Remember to calculate margin on prices excluding VAT. VAT collected belongs to HMRC, so including it overstates both sales and margin.
Gross margin vs markup
Markup measures profit as a percentage of cost, not of the selling price. In the lamp example, the £24.50 profit is a 49% margin but a 96% markup. To hit a target margin, use: price = cost ÷ (1 − margin). For a 50% margin on a £25.50 cost, the price is £51.
Typical margins
Gross margins vary hugely: software and consultancy can exceed 70%, restaurants often run at 60% to 70% on food alone, and grocery retail can be below 30%. The useful comparison is with similar businesses and with your own trend over time.
Tracking it in practice
For accurate monthly gross margin, stock must be counted or tracked at each month end. Otherwise purchases are expensed when bought and margin jumps around.
Common questions
Gross margin only deducts the direct costs of what you sell. Net margin deducts everything: overheads, interest and tax as well. A business can have a strong gross margin and still make a loss if its overheads are too high.
Include the cost of staff who directly deliver the product or service, such as chefs in a restaurant or billable consultants, if you want a true picture of each job's profitability. Admin, sales and management salaries are overheads and sit below the gross profit line.