How profit margin is worked out
Gross profit is what is left of the selling price after you pay for the thing you sold. Gross margin shows that profit as a share of the price. The calculator uses:
- Gross profit = revenue - cost
- Gross margin % = gross profit / revenue x 100
- Markup % = gross profit / cost x 100
- Price for a target margin = cost / (1 - target margin / 100)
You can enter figures for a single item or for a whole month of sales. The percentages come out the same either way, as long as revenue and cost cover the same period and the same goods.
A worked example
A candle maker sells a candle for $120 a box. Wax, jars, wicks and packing cost $75 a box. Gross profit is $45, so the gross margin is 45 / 120, which is 37.5%. The markup on cost is 45 / 75, or 60%.
The maker wants a 40% margin. Using the target formula, 75 / 0.6 gives a price of $125. A $5 rise per box takes the margin from 37.5% to 40%.
Gross margin is not take-home profit
This tool measures gross margin, the first and simplest layer. Net margin takes away everything else the business pays: rent, wages, software, advertising, loan interest and tax. A product line with a 60% gross margin can still lose money once those costs are counted.
Gross margin is still the number to watch week to week. It tells you whether each sale pulls its weight before overheads, and it moves straight away when a supplier raises prices or you start discounting.
Common mistakes
- Mixing up margin and markup when setting prices, which leaves the margin lower than planned.
- Leaving out shipping, payment fees or returns from the cost figure.
- Comparing your margin with a different kind of business. A cafe and a software firm will never look alike.
