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Gross margin and what it tells you
Gross profit is revenue minus the direct costs of producing goods or delivering services — materials, direct labour, subcontractors, and similar items. Gross margin (as a percentage) shows how efficiently the business converts sales into gross profit before overhead. A falling gross margin signals either pricing pressure, rising input costs, or deteriorating product mix.
Lenders and investors use gross margin trends as an early indicator of competitive position. A 40% gross margin business that has fallen from 48% in three years has a story to tell, and if that story is unaddressed cost inflation, it may affect credit decisions.
Net margin and what it tells you
Net profit subtracts all costs — overhead (rent, salaries, utilities), depreciation, interest on borrowings, and corporation tax — from revenue. Net margin shows what percentage of every pound of sales the company actually retains. For a business with high revenue but thin net margin, a small revenue shortfall can quickly eliminate profit entirely.
EBITDA margin (earnings before interest, tax, depreciation, and amortisation as a proportion of revenue) is widely used by commercial lenders as a cleaner proxy for cash-generative capacity, stripping out capital structure and accounting policy differences that complicate net margin comparisons.
Using margin analysis in practice
Directors should track both metrics quarterly and benchmark against published sector averages from HMRC, ONS, or sector trade bodies. Where gross margin is healthy but net margin is poor, the issue lies in overhead structure — rent, staffing levels, or administrative costs. Where gross margin has compressed, the issue is closer to the production or delivery process.
- Segment gross margin by product line or customer — blended figures hide poor-performing revenue streams
- Present margin trends to lenders alongside revenue growth to demonstrate quality of earnings
- Avoid conflating gross margin improvement from reduced investment (cutting R&D or marketing) with genuine efficiency gains
Frequently asked questions
Can a business have a high gross margin but a negative net margin?
Yes. A software company with 80% gross margin can be deeply loss-making if it is spending heavily on sales, marketing, and research. High gross margin reflects pricing power and delivery efficiency, not overall financial health.
What margin level do lenders typically expect?
There is no universal threshold — acceptable margins depend entirely on the sector and business model. What matters to a lender is that the EBITDA margin is sufficient to service the proposed debt with meaningful headroom, typically an interest cover ratio above 1.5x to 2.0x.
Funding for UK limited companies
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