Pricing your products depends on a number of internal and external factors of your business.
One of these factors is the profit margin. But do you know how to calculate the ideal profit margin for your business?
What percentage should I earn on top of each product? Don’t worry, we’ll explain all of that in this article.
The first thing you need to understand is that profit margin is different from profit itself.
Well, how yes? That’s right! Basically, profit is the difference between the sale value and the cost value of that product.
The profit margin is a percentage obtained from the relationship between the profit and the total revenue of the business.
So the formula to calculate the profit margin would be this one:
Profit Margin = Total Profit/Revenues and at the end you multiply by 100.
Want an example in practice? So let’s do it! Let’s say you work in clothing sales and you bought a blouse from your supplier that cost $20 and you are selling the same blouse in your store for $50.
So, since the profit margin is profit divided by revenue, the calculation would look something like this: the profit, in this case, would be $30, since we are selling this shirt for $50 and we bought it for $20.
So the difference between the two is $30. So that would be our profit. Now we take that $30 and divide it by $50, which is the sale price for that item. This will give 0.6 which, multiplied by 100, gives 60%.
And that means that 60% of the sales value of this blouse is profit. But remember that this is gross profit or gross margin.
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Net profit margin
In the previous case, we did not analyze other business expenses, we only looked at the relationship between the selling price and the cost of that product.
And in addition to the gross profit margin, we also have the net profit margin, which, in addition to the costs related to the product itself, also includes other costs such as, for example, taxes and general business expenses.
So, the formula for calculating the net profit margin is:
Net margin = net income (after taxes) / total revenue.
And at the end we need to multiply by 100.
Going back to our previous example, if you pay 6% tax on that $50 sale, that would be a total of $3 in tax.
So, in this case, the profit that was $30 already drops to $27, that is, your net profit margin would look like this: 27/50 times 100 , which gives a total of 54%.
That would be your net profit margin. But, you might ask, how do I know if the profit margin I’m putting on my products is ideal?
As we already mentioned, there is no right answer to this.
To find out how to calculate your selling price and understand if the profit margin you entered is correct for your business, you will need to take a broader look.
For example, if your company is going through a difficult time or instability, it might be interesting for it to increase its competitiveness against its competitors. For this, you can decide to decrease your profit margin and increase the amount of sales.
Did you see how there is no such thing as an “ideal profit margin for all companies”? What exists is an ideal profit margin for each moment and for each company.
3 additional tips
Now, the crucial moment of this article: take these tips that we are going to give you to help you define the ideal profit margin for your business.
1. Correctly price your products
You need to price your products correctly. And this can be done through a formula called markup , which takes into account several factors that are important for each company.
2. Consider your costs, fixed and variable expenses
Another important point is that you consider your fixed and variable costs and expenses.
Never (under any circumstances) set your profit margin based on what you want to earn or what you think you deserve to earn.
It is essential to consider elements such as: labor, raw materials, number of hours worked, rent and so on.
3. Knowing how to differentiate profit from profit margin
As discussed at the beginning of the article, it is essential to know how to differentiate profit from profit margin, and then focus, in fact, on the profit margin, which is the percentage.
Thus, it is possible to price the items according to the demand that it has in the market.
It’s essential to be aware of everything that comes in and out of your company’s cash , because that way you’ll be able to better outline the objectives and you’ll be able to define a percentage to put on top of the products.