Skip to content

Cookies on Loupe

Essential cookies keep Loupe working and are always on. With your agreement, Loupe also loads analytics to count visits and see which pages and tools are used. There is no advertising tracking. You can change your choice at any time from cookie settings. Read the cookie policy

Loupe home

Gross margin

Gross margin is revenue minus the direct cost of what a business sells, shown as a percentage of revenue. It shows how much each sale contributes towards overheads and profit.
Last updated
Author
Loupe editorial
Reviewer
Not yet reviewed

Definition

Gross margin is revenue minus the direct costs of producing or buying what a business sells, expressed as a percentage of revenue. Those direct costs are usually called cost of sales or cost of goods sold. Overheads such as rent, office salaries and most marketing sit below the line. Businesses draw that line in different places, for example with delivery, payment fees or contractor labour, so margins are only comparable when the definitions match.

Worked example

Quillhaven Coffee Roasters is a fictional Australian business with sales of A$2,000,000. Green beans, packaging, roasting staff and shipping cost A$1,200,000.

  • Gross profit is A$800,000.
  • Gross margin is A$800,000 divided by A$2,000,000, which is 40%.

If the seller moved A$100,000 of shipping costs out of cost of sales and into overheads, gross margin would appear as 45%, though nothing about the business had changed.

Why buyers care

Gross margin shows pricing power and how much each extra sale adds towards covering overheads. A margin that slips year after year can be an early sign of rising supplier prices, heavier discounting or a shift towards less profitable products.

Compare the margin across at least two or three years on the same cost definitions before comparing it with other businesses. Ask the seller whether any costs have been reclassified, and check a sample of supplier invoices against cost of sales. For the same reason, the financials section of a Loupe dossier restates gross margin on normalised figures rather than taking the listed margin at face value.

Related terms

  • EBITDA

    EBITDA is earnings before interest, tax, depreciation and amortisation. It helps compare operating profit across businesses, but it is not the same as cash.

  • Seller's discretionary earnings (SDE)

    Seller's discretionary earnings is the yearly financial benefit a business gives one full-time working owner, before financing costs, non-cash charges and one-off spending.

  • Inventory at cost

    Inventory at cost is stock valued at what the business paid for it, not at the price it expects to sell it for. It is the usual basis when stock is added to a purchase price.

  • Trailing twelve months (TTM)

    Trailing twelve months means the most recent 12 consecutive months of figures, whatever the financial year. It gives a more current view than the last set of annual accounts.

  • Customer lifetime value

    Customer lifetime value estimates the total gross profit a business earns from an average customer over the whole relationship. It is a model built on assumptions, not a record.

  • Customer acquisition cost

    Customer acquisition cost is the average sales and marketing spend needed to win one new customer over a period. It shows whether growth can be repeated and at what price.

Guides

  • How to read a business-for-sale listing

    A listing is a sales document written to win enquiries. This guide shows how to read its numbers, its wording and its gaps, and how to turn them into questions before you sign an NDA.

    10 minutes to read

  • Buying an online business: SaaS, ecommerce and content compared

    SaaS, ecommerce and content businesses are sold on the same marketplaces, but they earn money differently, fail differently and are valued differently. This guide compares the metrics, risks and diligence for each.

    9 minutes to read

  • Due diligence: what to check and in what order

    A sequence for due diligence that tests what could end the deal first, while it is still cheap to find out, and leaves the detailed and expensive work until the deal looks sound.

    10 minutes to read

Red flags

  • Margins far above industry norms

    Profit margins well above similar businesses can reflect a real advantage, but more often costs are missing, have been moved elsewhere or have not been paid yet.

    Severity: price it inFinancials

  • Heavy discounting to hit targets

    Revenue bought with deep discounts, cut-price prepaid deals or stock pushed onto resellers flatters the final year before a sale and is unlikely to last.

    Severity: price it inCustomers and revenue

  • Supplier or single-source manufacturing concentration

    When one manufacturer, wholesaler or platform supplies most of what a business sells or relies on, that supplier controls your margin and your ability to trade. Price in the cost and time of switching.

    Severity: price it inOperations and people

Back to the glossary, A to Z