To ensure that you are making money at the end of the day, it's important to know what your sales margin is. Sales margin represents the amount of extra money that you charge a customer based on a product's cost. It's the same thing as gross profit margin or, more simply, margin. Sales departments or sales companies usually use the term sales margin, while a manufacturer may use the term gross profit margin.
Sales margin can be calculated by subtracting the cost from the sales price of a product and then dividing that amount (net profit) by the sales price.
The sales margin formula, or gross profit margin formula, is easy to put into practice. For each product you sell, first calculate how much it costs you to create and sell that product. Total costs include labor, materials, marketing and shipping.
- Determine how much you sold the product for. This is your total revenue.
- Subtract the total cost from the total revenue to determine the net profit.
- Divide the net profit by total revenue to determine your sales margin.
For example, suppose you made a product that cost you $13 to produce, which you sold for $20. Subtracting the sales price from the total cost gives you a net profit of $7. Dividing the $7 net profit by the $20 revenue gives you a sales margin of 35 percent.
The key is to make sure that your sales margin is enough that you can meet your business growth objectives. If the sales margin is too low, you will need to increase your pricing or find a way to reduce your costs.
Markup represents how much you price an item based on its cost. Markup can be calculated by subtracting the total cost from the sales price and then dividing that number by the sales price. However, if you know the sales margin, you can also use it to calculate markup.
First, subtract the sales margin (a percentage) from 1 and then divide that number by your margin. For example, if your margin is 35 percent, subtracting 0.35 from 1 gives you 0.65. Dividing 0.35 by 0.65 gives you 0.538, or 54 percent markup. Multiplying the cost of an item by the markup also gives you the right sales price.
Similarly, if you know the markup of an item, you can calculate the sales margin by adding 1 to the markup percentage and then dividing the markup by this number. Thus, in our example, dividing 54 percent markup by 1.54 gives you 35 percent margin.
- Markup = Margin(1-Margin)
- Margin = Markup(1+Markup)
Research has shown that consumers don't think about price as much as one may think. Research has shown that about half of all consumers cannot remember the exact price of an item even just a few seconds after picking it up from a shelf. Instead of focusing on the exact price, consumers rely on their perceptions of the price compared to their perception of the product's value. There are many factors that can affect these perceptions, including their experiences with similar products, product packaging and the consumer's income level. Understanding your primary market is paramount to determining how to present and price your products.
This is why some companies rely on the perceived value of a product when determining price rather than basing the price on a margin over cost. Intel, for example, regularly sells processors at a higher price when they are first released and then reduces the price as time goes by. Similarly, you may find a small jar of hand cream in either an elegant or medicinal-looking package at twice the price as large bottle, even though they may contain the same ingredients.