Profit margin, what is the formula to calculate it?
Posted: Wed Dec 18, 2024 6:07 am
When it comes to pricing your product or service, the profit margin is the amount you want to earn from the transaction. In this post we describe the main keys to profit margin and the formula for calculating it.
The profit margin represents the amount we want to earn on each trade.
A very high margin is not always the most appropriate.
The profit margin is one of the important issues we want to know when we talk about prices . It guides us on how income is transformed not only into returns to productive resources, but also into profit generation .
However, understanding profit margin poses certain challenges . The profit margin depends on decisions in which there are several issues that we must consider. This is why it czechia email list is a concept in which we must not only consider what it is and how it is calculated, but also its own limitations.
Download the FREE guide “How to manage your company’s liquidity”
The profit margin formula
We define the profit margin as a percentage of the price that is above the cost . It represents the profit we obtain with each sale. Its formula is:
Let's imagine that, for example, we have a cost of 12 and we want to know what price the profit margin is for 25%. To calculate it, we would proceed as follows:
We see how, with a price of 16, 75% goes to covering costs and the other 25% to generating profits.
Also, remember that, to the price before taxes , we must add the impact of VAT and other indirect taxes and, if applicable, the operating costs . If, for example, the only tax affecting our product is the 21% VAT, we would have to:
PVP=16*1.21=19.36 where PVP is the retail price.
Sage
In this article you will discover the importance of analyzing financial information and profit margin.
The profit margin depends on the quantity produced
In the simple examples we have given, we knew what the prices and costs were. However, the reality is a little more complex. Both are variables that can depend on the quantity produced .
How prices depend on the quantity produced
When it comes to prices, some companies simply have to accept what the market dictates . This would be the case if we were a very small company with many competitors who do exactly the same thing as us. In that case, we cannot charge more than others, as we would lose customers.
However, most companies do have some pricing power . Your product may be similar to that of other competitors , but with certain unique features. Chances are, there are customers who are willing to pay a little more.
Logically, even if some customers like us, the number of them willing to buy from us will decrease as we raise the price. That is, a higher profit margin may imply a fall in the quantities demanded .
A very high profit margin can translate into a reduction in the quantities demanded by customers of our product.
How costs depend on the quantity produced
The same thing happens with costs. There is a part of them that does not depend on the quantity produced, the so-called fixed costs . But there are other variable costs that reflect that producing more implies requiring more resources. An example of this would be labor costs .
In general, when there is little production, increasing production means that the costs per unit of product are reduced. Fixed costs are distributed among more units of the good or service that we produce. Variable costs are reduced because we can take advantage of the advantages of size and division of labor.
However, there comes a time when variable costs begin to grow. Size represents an organizational and information management challenge . The resources employed have made their main contributions to the business and their productivity begins to decrease .
The profit margin represents the amount we want to earn on each trade.
A very high margin is not always the most appropriate.
The profit margin is one of the important issues we want to know when we talk about prices . It guides us on how income is transformed not only into returns to productive resources, but also into profit generation .
However, understanding profit margin poses certain challenges . The profit margin depends on decisions in which there are several issues that we must consider. This is why it czechia email list is a concept in which we must not only consider what it is and how it is calculated, but also its own limitations.
Download the FREE guide “How to manage your company’s liquidity”
The profit margin formula
We define the profit margin as a percentage of the price that is above the cost . It represents the profit we obtain with each sale. Its formula is:
Let's imagine that, for example, we have a cost of 12 and we want to know what price the profit margin is for 25%. To calculate it, we would proceed as follows:
We see how, with a price of 16, 75% goes to covering costs and the other 25% to generating profits.
Also, remember that, to the price before taxes , we must add the impact of VAT and other indirect taxes and, if applicable, the operating costs . If, for example, the only tax affecting our product is the 21% VAT, we would have to:
PVP=16*1.21=19.36 where PVP is the retail price.
Sage
In this article you will discover the importance of analyzing financial information and profit margin.
The profit margin depends on the quantity produced
In the simple examples we have given, we knew what the prices and costs were. However, the reality is a little more complex. Both are variables that can depend on the quantity produced .
How prices depend on the quantity produced
When it comes to prices, some companies simply have to accept what the market dictates . This would be the case if we were a very small company with many competitors who do exactly the same thing as us. In that case, we cannot charge more than others, as we would lose customers.
However, most companies do have some pricing power . Your product may be similar to that of other competitors , but with certain unique features. Chances are, there are customers who are willing to pay a little more.
Logically, even if some customers like us, the number of them willing to buy from us will decrease as we raise the price. That is, a higher profit margin may imply a fall in the quantities demanded .
A very high profit margin can translate into a reduction in the quantities demanded by customers of our product.
How costs depend on the quantity produced
The same thing happens with costs. There is a part of them that does not depend on the quantity produced, the so-called fixed costs . But there are other variable costs that reflect that producing more implies requiring more resources. An example of this would be labor costs .
In general, when there is little production, increasing production means that the costs per unit of product are reduced. Fixed costs are distributed among more units of the good or service that we produce. Variable costs are reduced because we can take advantage of the advantages of size and division of labor.
However, there comes a time when variable costs begin to grow. Size represents an organizational and information management challenge . The resources employed have made their main contributions to the business and their productivity begins to decrease .