Glossary
Net margin
Net margin is the percentage of revenue that remains as profit after every cost of running the business has been deducted, not just the direct costs of delivering a project. Where gross margin stops at delivery cost, net margin accounts for overhead, admin salaries, software, rent, taxes, and interest too. For agencies and professional services firms, net margin is the number that answers the real question an owner is asking: after everything, how much of what we billed did we actually keep?
How to calculate net margin
Net margin is calculated by subtracting every cost the business incurs, direct and indirect, from revenue, then expressing what is left as a percentage of that revenue.
Direct costs are the billable team’s time and any project expenses, the same inputs used for gross margin. Indirect costs add everything gross margin leaves out: salaries for non-billable staff, office and software overhead, management time, interest, and tax. A firm can post a healthy gross margin and still have a thin or negative net margin if its overhead is too heavy for its revenue.
Net Margin (%) = ((Revenue - Total Costs) / Revenue) × 100
Example: an agency earns $500,000 in revenue. Direct delivery costs are $275,000 and overhead (salaries for non-billable staff, rent, software, admin) is $140,000. Net margin is (($500,000 - $415,000) / $500,000) × 100 = 17%.
What net margin looks like at agencies
Net margin benchmarks run lower than gross margin benchmarks because every overhead line is already subtracted. Most healthy agencies land somewhere between 10% and 20% net margin; well-run firms with tight overhead control can push past 20%.
Net margin under 5% leaves almost no buffer for a slow quarter, a client loss, or an unplanned hire. A firm can look busy and still be running close to break-even if its net margin sits in that range, which is why owners track it alongside revenue growth rather than instead of it.
Net margin vs gross margin
Gross margin shows whether delivery itself is priced and run well: revenue minus the direct cost of the people doing the work. Net margin shows whether the whole business is sustainable once every other cost is counted. A firm can run 45% gross margin on its projects and still land at 8% net margin once overhead, admin, and tax are subtracted.
Watching the gap between the two numbers is useful on its own. A growing gap usually means overhead is growing faster than revenue, often from adding management layers or tools ahead of the billable headcount needed to support them.
Example
A 25-person agency bills $2.1M in a year. Direct delivery costs (billable salaries, freelancers, project expenses) total $1.15M, giving a 45.2% gross margin. Overhead for the year, non-billable salaries, office, software, management time, and interest, adds another $630,000. Net margin is (($2.1M - $1.78M) / $2.1M) × 100 = 15.2%. The 30-point gap between the firm’s gross and net margin is entirely overhead, which is where the owner looks first when margin needs to improve.
