Over the past 25 years I’ve come across several businesses that have made one simple mistake when calculating profits. When I’ve pointed it out and explained it they’ve been astounded that something so simple has got past them for many years!
How Are You Working Out Your Profit?
For this example let us just assume that a business buys products in and resells them at a profit. For arguments sake, let’s assume that this is a shoe shop. For years, the company has stuck to the same principle when deciding on a selling price.
The shoe shop buys shoes in from manufacturers and then adds 40% to the cost. Let’s leave tax out of this for now as the readers of this blog are from different countries around the world each with a different tax regime and it would only confuse matters.
So, lets for arguments sake use a pair of shoes that cost £100 ( 0r $100 if that’s your currency) The shop simply adds 40% to the cost price and sells them for £140. Are you following?
So, if it does this for every pair of shoes that it buys in, simply adds 40% to the cost price then would you agree that the shop is making 40% gross profit ( before any overheads are deducted)? So assuming that sales in one week were £10,000 then it’s reasonable to assume that the gross profit is £4000 right?
You’d be wrong! Here’s why:
Cost of Shoes £100
Selling Price £140
£40 isn’t 40% of £140 – It’s 28.57%
To find out what our gross profit is we need to take the selling price minus the cost and then divide that figure by the selling price then multiply by 100.
Selling price (£140) – The Cost ( £100) = £40 divided by Selling Price (£140) x 100 = 28.57%
So, if the shoe shop had a weekly sales figure of £10,000 then it’s gross profit would be £2857 which is considerably less than the £4000 profit that it had planned for.
This is such a common mistake that I’ve seen time and time again, Profit on cost is a totally different figure to gross profit and can easily see a business get into trouble.
How To Work Out A Mark Up Price
It’s not actually as hard as you may think. Simply decide on the gross profit you want to make eg 40%.
Now take that figure and deduct it from 100, so, assuming we want to make 40% GP then 100-40=60.
Then divide that result by 100 ie. 60 ÷ 100 = 0.6.
Finally, simply divide your cost price by that result to work out your required selling cost to get the profit margin that you desire ie £100 ÷ 0.6 = £166.67.
Selling price = Cost Price ÷ ((100 − desired GP) ÷ 100)
Thankfully there is an easier way and if you look at the following examples then the above formula will start to make sense.
For a five percent GP, divide the cost price by 0.95
For a ten percent GP, divide the cost price by 0.9
For a fifteen percent GP, divide the cost price by 0.85
For a twenty percent GP, divide the cost price by 0.8
For a twenty-five percent GP, divide the cost price by 0.75
For a thirty percent GP, divide the cost price by 0.7
For a forty percent GP, divide the cost price by 0.6
And so on, you should start to see a pattern here.
If this has made your head hurt then fear not, there are several markup calculators available. See a selection below that I can recommend.