Are you making as much profit as you think on the products and services that you offer?
I recently had conversations with 2 established business owners who didn’t realise that the way they calculated their profit margin was wrong and was in fact less than they thought it was. For one this came as a particular shock and I could see that it was dawning on him that he had been under pricing his work for years.
If you calculate your price based on making a specific profit percentage (profit margin) over your costs then please read this post to make sure you’re getting this right. In it I’ll take you through how they and you should calculate your profit margin, in order to receive the profit your business needs to make.
When I asked these business owners how they calculated their prices based on making a specific profit margin, they said they worked out their costs and added that percentage.
Now, I’m not going to discuss here how you should price your product and services – I’ll do that in another post. But if this is how you work out your prices then you’re actually charging less than you should be.
The profit you aim to make will depend to some degree on the industry you’re in, but generally for a small to medium-sized business you should be aiming to make a net profit margin of at least 30%.
Profit is the actual amount your business earns after expenses are taken from your revenue. Profit margin is the equivalent in terms of a percentage. For clarity, your gross profit is what you make minus the cost of the product sold. Your net profit is what you’re left with after all your business’ expenses have been taken off. From now on I’ll simply refer to profit.
So, if you sell something for £100 and it cost £70 to manufacture then your profit is £30 and your profit margin is 30%. The profit is based on the sale price.
So, how do you calculate what the sales price should be in order to make a 30% profit margin from your costs?
As I said previously, these business owners stated they took their costs and added, say 30%. In this case they would take their £70 cost and add 30%. But £70+30% = £91 not £100. They had calculated 30% of the £70 cost, which is £21.
This is not 30% of the sale price and hence this is not 30% profit margin.
They actually only made a profit of 23%. 70/91 = 0.77. Take that number from 1 and you have 0.23 or 23%. (23% of £91 is £21).
If you know your cost and you want to calculate how much to sell your product or service that will give you a profit margin of 30%, you simply need to divide that cost by 0.7.
£70/0.7 = £100
30% of 100 is 70.
If your costs for a piece of business is say, £5,755 and you simply add 30%, you have calculated 30% of your cost and your sale price will be £7481.50 and your actual profit margin 23%.
If you calculate 30% profit margin correctly, your sale price will be £8,221.43. That’s a not insignificant difference of £739.93.
You can easily double-check this: £8221.43-30% = £5755. Or 30% of £8221.43 is £2,466.43. Take that away from £8221.43 and you have £5,755.
If you want to make 35% profit margin on top of your costs then divide by 0.65.
- 40% then divide by 0.6;
- 50% then divide by 0.5;
- 60% then divide by 0.4 and so on.
Your business needs to make at least 30% net profit if it is to be financially healthy so please make sure that if you calculate your sale price from your costs that you do not inadvertently reduce your profit and weaken the financial viability of your business.
This is such a common mistake that can make the difference between struggling and doing ok for many business owners. If you can think of anyone who may be making this mistake then to be on the safe side share this post with them and help them out. It’ll cost you nothing but this could be costing them a lot.