Glossary
Gross margin
Gross margin is the percentage of revenue remaining after subtracting the direct costs of delivering services. For agencies and professional services firms, it represents how much of each pound or dollar of revenue is left to cover overhead, pay for growth, and generate profit. It is one of the most important metrics for assessing the financial health of an agency.
How to calculate gross margin
Gross margin is calculated by subtracting direct costs from revenue and expressing the result as a percentage of revenue.
For an agency, direct costs typically include the salaries and benefits of billable staff, freelancer and subcontractor costs, and any direct project expenses billed to that project. Overhead costs like office rent, software subscriptions, and management salaries are not included in the gross margin calculation.
Gross Margin (%) = ((Revenue - Direct Costs) / Revenue) × 100
Example: an agency earns £100,000 on a project with £60,000 in direct delivery costs has a gross margin of 40%.
What gross margin looks like at agencies
Gross margin benchmarks vary by agency type, but most agencies target 40-60% gross margin. Marketing and creative agencies tend to run 45-55%. Technology and consulting firms vary more widely based on whether delivery is mostly senior or junior labour.
Gross margin below 35% usually means the agency is not covering overhead and profit from its revenue, which leads to financial pressure. Above 65% on a sustained basis often indicates the agency is under-investing in delivery quality.
The difference between gross margin and net margin
Gross margin subtracts only direct costs. Net margin subtracts all costs, including overhead, and represents the final profit percentage. For a healthy agency, the gap between gross margin and net margin is the overhead burden, and understanding that gap is essential to financial planning.
Example
An agency invoices a client £80,000 for a three-month project. The direct costs are £44,000 (salary time of the project team plus one freelancer). The gross margin is ((80,000 - 44,000) / 80,000) × 100 = 45%. The agency's overhead for those three months (shared across all projects) is £15,000, so the net contribution from this project to overhead and profit is £21,000.