If wages feel tight even when revenue is up, it’s rarely turnover’s fault, it’s gross margin. Get this right and everything else gets easier: hiring, cash, and confidence.
Who this guide is for (service businesses only)
This is for UK service-based SMEs, professional services (accountancy, legal, architecture/engineering), consultancies, creative/marketing agencies, IT & managed services, recruitment, education & training, and other office-based services. These sit inside the UK service sector, which accounted for roughly 81% of UK output and 83% of employment in April–June 2025.
1) What gross margin is (and isn’t)
- Gross profit (GP) = Revenue − Cost of Sales (COS) (also called COGS).
- Gross margin % = GP ÷ Revenue × 100, the share of each £1 of sales left to pay overheads and profit.
Example: Invoice £100; spend £40 directly delivering the work (COS) → GP £60 → gross margin 60%. After overheads, what’s left is EBIT (Earnings Before Interest and Tax), your operating profit. For a clear refresher on gross vs net profit, see Starling’s small-business guide. Starling Bank
Plain-English rule: Margin is about the price you charge; COS is about the direct costs to deliver.
Internal link: Core Finance Formulas for UK Service SMEs.
2) What belongs in COS for services (and what does not)
Many service firms mis-classify costs and end up with misleading margins.
Typically COS in services (direct to delivery):
- Subcontractors/freelancers doing client delivery
- Direct delivery staff time (billable work, not admin/account management)
- Project-specific travel, specialist software/licences or materials used for that job
- Transaction fees you treat as direct to that sale
This aligns with UK guides: COS = direct costs linked to the goods or services you sell; indirect costs (rent, admin, marketing, core software) sit below gross profit as overheads.
Usually not COS (overheads):
- Directors’ salaries not delivering work, admin/support salaries
- Sales & marketing, rent, core software stack, insurance, training
- Account management time outside the scoped deliverable
Why it matters: Put overheads into COS and you under-report margin (and under-price). Leave truly direct costs in overheads and you overstate margin (false confidence). A simple COS policy, by service line, prevents drift.
3) Margin vs markup (stop mixing them up)
- Gross margin % = profit as a % of the selling price.
- Markup % = profit as a % of the cost.
On the same job, markup is always higher than margin because the denominators differ. Use one consistently and know how to convert. (Xero’s glossary explains the distinction well.) xero.com
Internal link: Pricing & Markup explainer.
4) What’s a “good” gross margin for UK service firms?
Benchmarks are a guide, not a law, models and utilisation (share of staff time on billable delivery) vary. Directionally:
- Agencies (UK): BenchPress 2025 reports average GP for £1m+ agencies fell to <40%, while the target remains ~50% (only ~24% hit it).
- Consulting/professional services: Industry analyses link stronger utilisation and project visibility to higher margins; well-run firms can achieve 60%+ GP with disciplined scoping and pricing.
How to use this: Set a firm-wide target, then track by client and service line. Trends beat one-off snapshots.
5) Worked example: why a 2-point lift changes everything
| Item | Amount |
|---|---|
| Revenue | £1,200,000 |
| COS | £480,000 |
| Gross profit (GP) | £720,000 |
| Gross margin | 60% |
| Overheads | £600,000 |
| EBIT (operating profit) | £120,000 |
Lift gross margin to 62% at the same revenue → GP £744,000 → EBIT £144,000.
That’s +£24,000 EBIT (+20% profit) from a 2-percentage-point margin lift.
6) Five levers to lift margin (without burning goodwill)
- Pricing discipline – minimums, annual indexation, unbundle “extras”, price outcomes.
- Service mix – grow higher-margin lines; productise repeatable advisory.
- Delivery efficiency – raise utilisation, reduce rework; standardise templates/QA/tooling.
- Supplier & subcontractor rates – frameworks, volume pricing; track effective day rates by project.
- Scope control – change-order rules; discount only when you de-scope.
Research consistently links better project visibility (PSA + finance) with stronger margins, invest in the operating system behind your delivery.
7) Common traps that kill margin in services
- Logging account management inside delivery when it’s not scoped
- “Package” pricing with hidden, variable effort
- Contractor creep (outsourcing core delivery without repricing)
- Discounting without removing scope
- Mis-classifying costs (e.g., job-specific software left in overheads)
8) How to monitor margin weekly and monthly
- Job-level GP: After each project/sprint, confirm revenue, direct labour/subcontractor time, and job-specific costs.
- Client & service-line view: Your monthly management pack should show GP% by client and by service so you can spot under-priced work early.
- Board rhythm: Close the month and publish the pack within seven working days so decisions happen while the period is still fresh.
Internal link: Management accounts in seven working days.
FAQ: quick answers for service-sector owners
Q1) Should employee wages be in COS or overhead?
If the staff member is directly delivering the service (billable), their delivery time belongs in COS; non-delivery roles (admin, sales, leadership) are overheads. The principle is to include direct delivery costs in COS so margin reflects the real cost of serving the client.
Q2) Are subcontractors/freelancers always COS?
Usually yes when they perform delivery work on a client engagement. If they’re doing admin/marketing/internal projects, treat that as overhead. (Document this in your COS policy so everyone codes consistently.)
Q3) What is a healthy gross margin for agencies/consultancies?
Directionally, agencies often target ~50% GP (many run below); consultancies/professional services can reach 60%+ with tight scoping, pricing and utilisation. Track your own trend by client/service.
Q4) Margin vs markup, what’s the difference (and why it matters)?
- Margin % = (Price − Cost) ÷ Price × 100
- Markup % = (Price − Cost) ÷ Cost × 100
- Same job, different %s: Cost £80 → Price £100 → Profit £20 → Margin 20%, Markup 25%
- Convert fast: Margin = Markup ÷ (1 + Markup) · Markup = Margin ÷ (1 − Margin)
Use margin for targets/boards and markup in quoting—just convert so sales and finance stay aligned. Xero’s UK glossary and calculator back these definitions. xero.com+1
Margin ↔ Markup quick reference
| Gross margin | Markup |
|---|---|
| 20% | 25% |
| 33.3% | 50% |
| 40% | 66.7% |
| 50% | 100% |
See Guide for further read :
Q5) How often should we review margin?
- Weekly: job/sprint GP to catch scope creep and rate issues
- Monthly: client & service-line GP% in your pack (published within seven working days)
- Quarterly: reset target rates/service mix if margins drift
Q6) Does utilisation really move margin?
Yes. Higher utilisation (share of time on billable delivery) improves project margins when pricing and scope control are in place; SPI/Deltek frequently cite ~80% billable utilisation as a structured-firm target.
Book a 20-minute planning call and we’ll:
- map what truly belongs in your COS (by service line)
- set a realistic gross-margin target for your model
- design a simple reporting rhythm so you see margin by job, client and service, every month