Three Numbers That Investors Always Ask About
Investors ask about gross margin in virtually every financial conversation with a fintech or SaaS business. But the reliability of that answer depends entirely on whether the business is calculating gross margin correctly — and the most common error is a subtle but important one: including costs in COGS that belong in operating expenses, or vice versa. A business that excludes payment processing fees from COGS will report a materially higher gross margin than a business that correctly includes them. The number looks better, but it is wrong, and an investor doing diligence will find the error.
Contribution margin is used less frequently in investor conversations but is arguably more useful for internal pricing and operational decisions. It answers a question that gross margin cannot: for this specific product line or customer acquisition channel, does the incremental revenue more than cover the incremental cost of generating it? A positive contribution margin means the product is worth continuing; a negative contribution margin means the business is destroying value with every unit sold, regardless of how fast it is growing.
Operating leverage describes the structural relationship between revenue and profit — specifically, how much of an incremental pound of revenue falls to the bottom line. A business with high operating leverage generates disproportionately large profit increases from revenue growth, but also experiences disproportionately large profit declines from revenue shortfalls. Understanding where your business sits on this spectrum is essential for forecasting and scenario planning.
Gross Margin: The Definition and What Belongs in COGS
Gross margin is revenue minus cost of revenue (also called cost of goods sold or COGS), expressed as a percentage of revenue. The formula is straightforward. The complexity is entirely in the question of what belongs in COGS for a fintech or digital business, where the traditional manufacturing cost categories do not map cleanly onto the cost structure.
The governing principle is that COGS should include costs that are directly and necessarily incurred in delivering the product or service to the customer — costs that would not be incurred if revenue were zero. The following costs belong in COGS for a typical fintech:
- Payment processing fees and interchange costs: if the business passes through or absorbs card network fees, acquirer fees, and interchange to deliver a payment product, these are direct delivery costs.
- Fraud losses: for payment and lending products where the business bears fraud risk, realised fraud losses are a cost of delivering the service.
- Cloud hosting and infrastructure directly attributable to revenue delivery: the cost of the servers and services that actually run the product. Not the cost of development infrastructure or testing environments.
- Customer support for technical product issues: support costs related to product delivery problems (an onboarding failure, a payment error, a technical bug) are a delivery cost. General account management is not.
- Card production and fulfilment costs: for card-issuing businesses, the cost of manufacturing and posting physical cards to customers.
The following costs do NOT belong in COGS and should sit in operating expenses:
- Sales and marketing: the cost of acquiring customers is not a cost of delivering the product to customers who have already been acquired.
- General and administrative costs: finance, HR, legal, office costs.
- R&D and product development: the cost of building future functionality, not delivering current functionality. Note: some companies capitalise a portion of R&D under IAS 38, which further reduces the apparent R&D expense in the P&L.
Worked Example: A B2B Payments Platform
Consider a B2B payments platform with annual revenue of £5m. The business charges a 1.5% fee on payment volumes, with interchange and processing costs of 0.7% passed through to the business. The business also hosts its own payment infrastructure (£100,000 annual cloud cost directly attributable to transaction processing) and employs a team of three payment operations specialists who handle transaction exceptions and disputes (fully loaded cost of £150,000 per year).
Correctly calculated COGS: interchange and processing costs of 0.7% on £5m / 1.5% = £333m of payment volume = £2.33m; plus cloud infrastructure of £100,000; plus payment operations of £150,000. Total COGS: £2.58m. Gross margin: (£5m minus £2.58m) / £5m = 48.4%.
If the business incorrectly excluded interchange costs from COGS: gross margin would appear to be (£5m minus £250,000) / £5m = 95%, which is a number that any investor familiar with payments businesses would immediately identify as wrong. The correct 48.4% is consistent with a payment-processing business benchmark of 30 to 50% and would not raise concerns.
Contribution Margin: The Incremental Decision Tool
Contribution margin is revenue minus all variable costs, where variable costs include not only COGS but also variable selling costs such as performance marketing, variable customer success costs (e.g., onboarding costs that scale directly with new customer additions), and variable infrastructure that scales with transaction volumes.
The key distinction from gross margin is the inclusion of variable sales and marketing costs. For a business that acquires customers through performance marketing channels (paid search, paid social), each incremental pound of acquisition spend is a variable cost that scales directly with revenue growth. Excluding it from the contribution margin calculation gives a misleading picture of the economics of adding a new customer.
Contribution margin per customer (or contribution margin per transaction) is the primary input into a unit economics analysis. The question it answers is: does acquiring and serving this customer generate more value than it costs? A positive unit economics calculation — where the lifetime value of a customer substantially exceeds the customer acquisition cost — is what investors are looking for. A business with a high gross margin but poor unit economics (because CAC is extremely high) is not a good business to invest in, regardless of what the gross margin appears to be.
Revenue per customer per year: £1,200
COGS per customer per year: £300 (25% gross margin)
Variable S&M per customer acquired (CAC): £400 amortised over 3-year average life = £133/year
Variable customer success cost: £60/year
Contribution margin per customer per year: £1,200 − £300 − £133 − £60 = £707 (59%)
This is the amount available to cover fixed costs and generate profit for each customer served. A business with £5m revenue and 4,167 customers at this unit economics has approximately £2.95m of annual contribution to cover its fixed cost base.
Operating Leverage: Fixed vs Variable Cost Structure
Operating leverage measures the degree to which a business's cost structure is fixed versus variable. A business with high operating leverage has mostly fixed costs: it costs a relatively fixed amount to operate, regardless of whether revenue is £5m or £10m. In a growth scenario, this means that incremental revenue flows almost entirely to profit — the business "scales." In a downside scenario, fixed costs continue even as revenue declines, meaning profit falls much faster than revenue.
The degree of operating leverage is often expressed as the ratio of the percentage change in EBIT to the percentage change in revenue. A business where a 10% revenue increase generates a 30% increase in EBIT has a degree of operating leverage of 3. A business where a 10% revenue increase generates a 10% EBIT increase has operating leverage of 1 — it is operating in a purely variable cost structure, which in practice is unusual.
"Operating leverage is not intrinsically good or bad. A high fixed-cost business in a growth market generates exceptional returns as it scales — but the same structure destroys value rapidly in a downturn. The CFO's job is to understand the leverage, model both scenarios, and ensure the board has seen both."
For fintech businesses, operating leverage typically increases from Seed through Series A and B as the team, infrastructure, and regulatory overhead are built out ahead of revenue. At this stage, the business has a high fixed-cost base relative to revenue, meaning it burns cash even at modest revenue. As revenue scales past the fixed-cost base, margin expansion is rapid. This is the "hockey stick" profile that venture investors are looking for.
How These Metrics Flow Together
The three metrics describe successive layers of the P&L cascade from revenue to profit. Gross margin captures the direct delivery economics: what is left after serving customers who have already been acquired. Contribution margin captures the full variable economics: what is left after acquiring and serving customers. Operating leverage describes how the fixed-cost base interacts with scale: as contribution margin grows, the fixed-cost base is increasingly well-covered, and profit grows disproportionately.
Benchmark Expectations by Funding Stage
Investors have different expectations for each metric depending on the funding stage, because the metrics tell a different story at different points in a company's development. At Seed stage, gross margin is the primary focus: is the unit economics of the product fundamentally viable? A Seed-stage business with negative gross margin is almost always a red flag, unless there is a credible and near-term path to positive gross margin through scale. At Series A, both gross margin and contribution margin are scrutinised: the business needs to demonstrate that it has positive unit economics and that marketing spend is generating customers efficiently. Operating leverage becomes a primary focus at Series B and beyond: the business should be demonstrating that revenue growth is beginning to outpace cost growth, generating margin expansion toward profitability.
Key Takeaways
- Gross margin measures delivery efficiency and is defined as revenue minus COGS. For fintechs, COGS must include payment processing fees, fraud losses, and directly attributable infrastructure and operations costs.
- Sales and marketing, R&D, and G&A do not belong in COGS. Including them understates gross margin; excluding costs that should be in COGS overstates it.
- Software-enabled fintechs should target 60 to 80%+ gross margin at scale. Payment processing businesses typically report 30 to 50% due to the pass-through nature of interchange and network fees.
- Contribution margin extends gross margin by deducting variable selling costs, including performance marketing and variable customer success. It is the correct metric for pricing decisions and unit economics analysis.
- A product line with a negative contribution margin is destroying value with every unit sold, regardless of how fast it is growing. Positive contribution margin is the minimum viable test for any product line.
- Operating leverage describes the sensitivity of profit to revenue changes. High fixed-cost businesses generate dramatic margin expansion in growth phases and dramatic margin compression in downturns. Both scenarios must be modelled.
- At Series B and beyond, investors expect to see operating leverage: revenue growth should be materially outpacing cost growth, delivering improving margins. If opex as a percentage of revenue is not declining as the business scales, the fundamental economics of the model require interrogation.
