Part 2. Calculating Margins is Simple. Avoid This Rookie Mistake!
By James Chittenden
If pricing products scares you, you’re not alone. Incorrect pricing is very common. Novice business owners sometimes price too high, earning the contempt of their market. However, it is far more common to price too low in an attempt to gain market share. Another rookie mistake is to just set markups and try to sell. Set accurate profit margins, NOT markups. There is a difference. Calculating margins is simple, so learn this simple way to set profit margins.
You need to add up what this business is costing you each month. This simple exercise is called a breakeven analysis. Do it regularly, because rising prices cause a ripple effect of other increasing costs that aren’t so easy to track. For example, higher property values tend to increase property taxes and insurance. Those higher bills can sneak up on you. This calculator can help you keep your break-even point and your budget accurate. This video explains how to arrive at a breakeven point and then set sales goals:
COGS (Cost of Goods Sold) is the direct cost of producing the goods that a company sells. It includes materials and labor required to produce the goods.
Contribution Margin. The Contribution Margin is how many dollars each individual item sold contributes to the total gross margin. It is the selling price of the item minus the variable cost per item, and those dollars are now available to cover fixed costs. Contribution Margin = Sales Revenue – Variable Cost
Each industry has a range of margins, so determine where you should be within that range. An example may be convenience stores, which in recent years generally set margins anywhere between 29 and 35 percent. The cleanest ones with the highest levels of service may be at the higher end, while high-volume, lower service quality may be on the lower end. If you don’t know the exact margins common in your industry, learn them.
Where can those be found? This site is free, but rather nonspecific about businesses within industries. However, it can serve as a guideline. Keep in mind that you may see it in “median” view, which means that the number provided is directly in the middle of the range. Half of the peer businesses will sell at higher margins and half will sell at lower. For more specific data on margins and other crucial financial measurements that accounts for your sales size, exact location, and exact business, see Bizminer.
Watch this simple one minute video to understand how margins are calculated and why.
Now, use this calculator to set profit margins correctly on every item you are selling.
Most businesses are selling multiple products with multiple profit margins. The best approach is to focus on total profits; the gross margin. This is the average of all of your individual units. Retailers of all sizes take this approach, and your business can too. This video explains how they do it.
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Marketing, because it brings in the customers. Start or continue that plan here.
Operations, because it keeps your customers. Start or continue that plan here.
Finance, because it is the scoreboard. Change the “score” and explore financing here.
Don’t let a simple math error cost you lost profits. Calculating margins correctly is simple.