Gross margin

Definition

Gross margin = (revenue − cost of goods sold) ÷ revenue, as a percentage. It shows the profitability of your core product or service before overheads.

In plain terms

It is how much of each sale is left to cover the rest of the business, once you have paid for making that sale. A falling gross margin quietly erodes everything below it.

Why it matters for your company

Watching gross margin over time reveals pricing and cost pressure early. See reading your profit and loss and the gross margin calculator.

In practice

Picture a UK limited company selling a physical product. Each order carries a clear direct cost — materials, packaging, the labour tied straight to production or fulfilment. Gross margin is what remains once those costs are stripped out of the sale price, before anyone in the business has covered rent, admin salaries, marketing or software subscriptions.

A director watching this figure month to month is really watching pricing discipline and supplier cost control at the same time. If a key input becomes harder to source, or a supplier quietly tightens terms, gross margin often moves before it shows up anywhere else in the accounts — which is why it is worth checking alongside, not instead of, the figures in reading your profit and loss.

Common pitfalls

The most frequent mistake is comparing gross margin across very different companies as if it were a single universal benchmark. A services business with almost no cost of goods sold will naturally show a different profile to one that manufactures or distributes physical stock, so the more useful comparison is a company against its own recent history.

A second pitfall is treating a single period's gross margin as the whole story. A dip caused by a one-off input cost spike reads very differently to a steady downward drift caused by underlying pricing pressure — only the trend line, not one snapshot, tells a director which situation they are actually in.