Skip to content

Glossary

Gross Margin

Revenue minus cost of goods sold (COGS), expressed as a percentage of revenue. A fundamental indicator of business unit economics and pricing power, analysed closely during M&A due diligence.

What Is Gross Margin?

Gross margin is calculated as (Revenue − Cost of Goods Sold) ÷ Revenue, expressed as a percentage. It measures how efficiently a company converts revenue into profit before operating expenses.

In M&A due diligence, gross margin is one of the first metrics buyers examine. It reveals pricing power, input cost exposure, and the scalability of the business model.

Why Gross Margin Matters in M&A

Gross margin is a key driver of EBITDA and enterprise value. Businesses with high and stable gross margins attract higher multiples because:

  • They have more pricing power and less commodity exposure
  • Operating leverage is typically higher — fixed cost bases amplify EBITDA growth
  • Margin expansion potential is more credible in a post-close business case

Buyers scrutinise gross margin trends over 3–5 years to identify:

  • Compression — whether margins are deteriorating due to input costs, pricing pressure, or customer mix shifts
  • Distortion — whether COGS classification is consistent (e.g., capitalised labour, indirect costs in COGS vs. operating expenses)
  • Customer concentration effects — whether large customers receive discounts that distort blended margin

Gross Margin by Sector

Gross margin benchmarks vary significantly by sector. Software businesses may operate at 70–85% gross margins, while manufacturing businesses may operate at 25–45%. Understanding sector norms is essential for deal pricing — a 40% gross margin might be exceptional in one industry and below average in another.

Gross Margin in Quality of Earnings

In a quality of earnings review, gross margin analysis typically includes:

  • Reconciliation of reported gross margin to normalised gross margin
  • Identification of one-off or non-recurring COGS items
  • Analysis of margin by product line, customer segment, or geography
  • Assessment of cost of goods sold classification consistency

Related Terms

EBITDA Add-Backs

Adjustments made to reported EBITDA to normalise earnings by removing one-off, non-recurring, or non-operational items — producing an adjusted EBITDA figure used as the basis for deal valuation.

EBITDA Multiple

A valuation ratio that expresses the enterprise value of a business as a multiple of its EBITDA — used in M&A to compare valuations across companies and assess whether a deal is fairly priced.

EBITDA

Earnings Before Interest, Taxes, Depreciation, and Amortisation — a widely used financial metric in M&A that measures a company's operating profitability before the effects of capital structure, tax policy, and non-cash accounting charges.

Normalised EBITDA

Normalised EBITDA is EBITDA adjusted for non-recurring, owner-specific, or one-off items to reflect the sustainable earnings a business would generate under new ownership. It is the primary metric buyers and M&A advisors use to establish enterprise value and negotiate acquisition price.