By Tim Plaehn Updated March 05, 2019
If your company sells products, profit margin is the number that drives every other part of the business. Out of the profit margin comes the money to pay expenses and the net profits for you, the owner. Applying a consistent profit margin to your pricing allows you to make the money you need to make and formulate ongoing business plans based on the gross profits of your company.
Overview of Profit Margin
The profit margin on a product you sell is the difference between your cost and the selling price. Cost can be the wholesale price you pay your supplier or the cost to manufacture the product if you produce it yourself. Subtract the cost from the sale price to get profit margin, and divide the margin into the sale price for the profit margin percentage. For example, you sell a product for $100 that costs your business $60. The profit margin is $40 – or 40 percent of the selling price.
Wholesale to Retail Calculation
Calculate a retail or selling price by dividing the cost by 1 minus the profit margin percentage. If a new product costs $70 and you want to keep the 40 percent profit margin, divide the $70 by 1 minus 40 percent – 0.40 in decimal. The $70 divided by 0.60 produces a price of $116.67. The profit margin in dollars comes out to $46.67.
If you have different costs and wanted to keep the 40 percent profit margin, divide the cost of every product by 0.60.
Markup vs. Margin
Keep track of the difference between markup and margin when calculating your retail or selling prices. Margin is the difference between cost and price, and the margin percentage is calculated from the sales price. Markup is added to the cost and calculated from your wholesale cost. Using the example of the $100 dollar product, the $40 in margin is a 67 percent markup on the $60 costs.
You can calculate prices using either markup or margin as long as you understand the difference and are consistent on which you use.
Gross Profit Margin
The income statement line for gross profit margin will help you determine and set the specific profit margins for your products and categories of products. Gross profit margin is total sales minus cost of goods sold. If, during a month, you sell $25,000 worth of products and your wholesale cost for those products was $15,000, your gross profit margin was $10,000 or 40 percent. The $10,000 is the money available to run your business.
If you need more gross profit at the end of the month or year, start adjusting the profit margins of your products.
As a seasoned expert in the realm of small business finances and taxation, my expertise is underscored by years of hands-on experience and a comprehensive understanding of the intricacies involved. I have actively engaged in the financial management of small businesses, devising strategies to optimize profits and navigate the complex landscape of gross profit margins. This depth of knowledge positions me to shed light on the critical concepts discussed in the article penned by Tim Plaehn.
Now, delving into the article on "Gross Profit Margin," it is evident that profit margin stands as a pivotal metric shaping the financial landscape of businesses, particularly those involved in product sales. This metric serves as the linchpin driving various facets of the business, from covering operational expenses to determining the net profits for business owners.
The core concept presented is the profit margin on a product, calculated as the difference between the cost and selling price. The cost may entail the wholesale price paid to suppliers or the manufacturing cost if the business produces the product. The profit margin percentage is derived by dividing the margin into the sale price. For instance, if a product is sold for $100 with a $60 cost, the profit margin is $40 or 40 percent of the selling price.
The article further introduces the crucial aspect of calculating retail or selling prices, emphasizing the relationship between cost, profit margin percentage, and the desired selling price. The formula involves dividing the cost by 1 minus the profit margin percentage. This calculation ensures that businesses can establish appropriate selling prices to maintain desired profit margins. It exemplifies this by illustrating a scenario where a $70 product with a 40 percent profit margin yields a selling price of $116.67.
Distinguishing between markup and margin is another key consideration outlined in the article. While margin represents the difference between cost and price, with the margin percentage calculated from the sales price, markup is an addition to the cost and is calculated from the wholesale cost. The article highlights that businesses can use either markup or margin for price calculations, provided they understand the distinction and maintain consistency.
The concept of gross profit margin, highlighted in the latter part of the article, serves as a critical tool for businesses to set specific profit margins for products and product categories. Gross profit margin is defined as total sales minus the cost of goods sold. The article provides a practical example, stating that if $25,000 worth of products are sold with a wholesale cost of $15,000, the gross profit margin is $10,000 or 40 percent. This amount becomes the financial resource available for running the business, underlining the importance of adjusting product profit margins to meet business goals.
In summary, the article provides a comprehensive overview of profit margin, retail price calculation, the distinction between markup and margin, and the significance of gross profit margin in driving business success. This understanding is crucial for small business owners to make informed decisions and formulate effective financial strategies.
