Gross Margin
The percentage of revenue that remains after subtracting the cost of goods sold. A key indicator of a business's pricing power and production efficiency, closely scrutinized by buyers.
Definition
Gross margin measures the share of revenue that remains after deducting the cost of goods sold (COGS) or the cost of services rendered. It’s calculated as: (revenue - COGS) / revenue x 100. For example, a business generating $2 million in revenue with $1.2 million in COGS shows a gross margin of 40%.
In French-language Quebec documentation, you’ll see marge brute used for the same concept.
COGS includes costs directly tied to producing or delivering the product or service: raw materials, direct labour, subcontracting. Operating expenses (rent, administration, management salaries) aren’t included in this calculation — they’re deducted further down in the income statement to arrive at operating income and EBITDA.
Why gross margin matters in a business sale
Gross margin is one of the first indicators a buyer analyzes to gauge the quality of a business. It reveals the business’s ability to turn revenue into profit before even considering operating expenses. A high gross margin points to a competitive advantage: pricing power, specialized expertise, production efficiency, or value perceived by customers.
Buyers systematically compare your gross margin to your industry averages. A Quebec professional services business with a 55% gross margin where the industry average is 45% sends a strong signal: it has something distinctive. That distinction translates directly into a higher valuation multiple.
On the other hand, a gross margin declining over 3 to 5 years is a red flag. It may signal growing competitive pressure, rising costs not passed on to customers, or dependence on low-margin contracts. Buyers will adjust their offer downward to reflect this risk, or ask for additional guarantees.
What every seller should know
- Know the average gross margin in your sector — if you’re above, it’s a powerful selling point; if you’re below, you need to be able to explain why.
- A stable or growing gross margin over 3 to 5 years reassures buyers about the sustainability of the business model and justifies a higher multiple.
- Make sure the COGS calculation is consistent from year to year: a change in expense classification can distort trend analysis.
- Improving your gross margin before going to market (supplier renegotiation, price adjustment, dropping unprofitable lines) is one of the most direct levers for increasing the value of your business.