How to calculate and improve gross margin

The formula

Gross margin is straightforward to calculate:

Gross margin % = (Revenue − Cost of Sales) ÷ Revenue × 100

So a company with £200,000 of revenue and £130,000 of cost of sales has a gross profit of £70,000 and a gross margin of 35%. That 35p in every pound is what's left to cover overheads, interest, tax — and, eventually, profit.

The critical discipline is what counts as cost of sales: only the costs that rise and fall directly with what you sell — materials, stock for resale, direct labour, delivery. Rent and admin salaries are overheads, not cost of sales, and don't belong in this calculation. Get that boundary wrong and your margin is meaningless. For the wider statement this sits within, see how to read a P&L.

Why gross margin matters so much

Gross margin is the engine room of the business. Every pound of overhead, every loan repayment, every tax bill and every penny of profit has to come out of gross profit. A high margin gives you room to absorb shocks, invest, and weather a quiet month. A thin one means even small disruptions push you into the red.

It also scales. Improving margin by a few points doesn't just help once — it lifts profitability on every future sale. That's why margin improvement so often outperforms cost-cutting or extra borrowing: it compounds across all your trading, not just a single line. A business with a structurally low margin is fragile no matter how busy it is.

What drags margin down

Margins erode quietly. The usual culprits:

• Rising input costs absorbed without raising prices — supplier increases you've swallowed to keep customers.
• Discounting to win or keep work, which cuts straight into margin.
• Waste and shrinkage — spoiled stock, rework, inefficiency in production.
• Product or customer mix shifting toward your lower-margin lines.
• Under-priced labour — quoting jobs that don't recover their true delivered cost.

Because each of these is small in isolation, they compound unnoticed until the bottom line suffers. Reviewing margin by product, service or customer — not just the blended average — is how you find where the leak actually is.

Levers to lift it

You raise gross margin in one of two ways: charge more, or spend less to deliver. Both have real levers:

1. Reprice deliberately. Even a modest, well-judged increase flows straight to gross profit. Most businesses under-price more than they over-price.
2. Negotiate cost of sales. Better supplier terms, bulk pricing, or switching inputs lowers the cost side directly.
3. Shift the mix. Steer sales effort toward your higher-margin products, services or customers.
4. Cut waste. Reduce rework, spoilage and over-servicing that quietly inflate delivered cost.
5. Re-quote loss-making work. Identify jobs or accounts that don't earn their margin and fix or drop them.

Track the effect after each change — margin improvement only counts if it sticks across the next quarter, not just the next invoice.

Margin first, finance second

If cash is tight, the instinct is to borrow. But borrowing against a structurally thin margin just adds a repayment to a business that already struggles to keep enough of each sale. Fix the margin first where you can, and the same finance does far more work.

That doesn't mean finance has no place — a healthy-margin business often borrows to buy better margin: bulk stock at a discount, equipment that lowers delivered cost, or capacity to take on higher-value work. Used that way, a facility funds the very improvement that pays it back. Credicorp lends to the company on its trading performance, with no personal guarantee, so a business that can show a strong, improving margin makes a stronger case. Before you apply, get the margin honest and the figures current — see preparing for a finance application.