How To Correctly Calculate Margin
TL;DR
Always use margin not markup and you will make more money and be better placed to handle discounting.
In the examples below we are going to calculate a sell price with a 30% margin. The cost price is $70
Step by Step
Convert 30% to a decimal 0.3 (divide by 100)
Minus 0.3 from 1 to get 0.7 (1-0.3)
Divide your cost price by 0.7 to get your sell price with a 30% margin!! (70/0.7=100)
For a Spreadsheet
The formula in the Sell Price field (C2) is:
= A2 / ( 1 - B2)
Read on if you care deeply about margin like me :-)
Margin makes sense.
I got excited writing this article about margin (weird I know). I love a good spreadsheet and I love pricing and margin sits right at this intersection. To me margin makes sense - you are calculating your gross margin or gross profit directly. Simple, easy and effective!
What is a margin and why is it important?
A margin is the amount of the total price over and above your costs. It’s equivalent to Gross Profit. It's mostly expressed as a percentage. It’s critical to know your margins. They have to be high enough to cover all your costs over and above the direct costs of the product. These direct costs are also known as Cost of Good Sold (COGS) or Cost of Sales (COS).
Your Gross Profit in your Profit and Loss statement is Revenue minus COGS.
Cost plus pricing
For cost-plus pricing, margin is superior to markup because businesses that use margin tend to sell at higher profitability than those using markup. This is a generalisation but in my experience, it works out. People tend to add a margin or markup that sounds reasonable (say 30%). So if you use margin your sale price will be higher than if you use markup.
If your cost price is $100 and you add a 30% margin, your sell price will be $143 ($100 / 0.7).
If you use a 30% markup your sell price will be $130 ($100 x 1.3) and your margin would be only 23%.
Margin works best for discounting
If you use markup and then discount by a percentage it’s very easy to get into trouble.
My favourite example was a company that told me they marked up their cost by 30% and then discounted by 20% for 36 month contract. Me “you are not making money”. Them “it's all good, we’re making 10%”. Nope, math fail.
$100 x 1.3 = $130
Less 20% discount. $130 x 0.8 = $104
They were only making a 4% margin!! (that was definitely not enough to make a profit).
Calculating margin (market based pricing)
It’s not always the right approach to add a margin to your costs. When you're pricing a product first understand where the market price is for competitive products. Then decide where your product fits in. Are you a market leader with a premium product (top end) or are you a budget/value provider (lower end)? What features do you have versus the competition etc?
Once you have created your sell price you need to calculate your margin.
Sell Price $100
Costs $77
Margin Calculation $100 - $77 = $23 Then 23 / 100 = 23% Margin.
Why does anyone use markup?
I don't like markup and I don't understand when it would be better to use it. If anyone out there can put forward a scenario where it’s better to use markup than margin I would love to hear it.
Key takeaway
Be a winner and always use margin!
In the ProductEngine app, we have made it even easier. We have a built-in function called MARGIN that ensures you never miscalculate.
One final thing
Also, if you’d like to try out the margin calculator column, with some of your own products and prices, we’re currently offering free access to our Open BETA.
It’s just launched, so feel free to check it out!