How Do You Calculate Profit Margin?

by on March 29, 2012 updated May 3, 2012

In pricing an item or service I have found there is a common mistake most people make.

Here’s the scenario: They’d like to have a 40% profit and usually take the cost, (let’s say that’s $100.00), and simply multiply it by 40% and add that figure to the $100 which is then assigned as the retail price. And based on that, most believe they’ve set the retail price appropriately to make a 40% profit! Zonk!

That’s not quite right, so let’s check this a little further. If you take $140.00 and multiply it by your target profit of 40% you’ll get an answer of $56.00. (I.e. $140.00 X 40% = $56.00.) Now subtract $56.00 from the $140.00 and you have only $84.00 where your cost was $100. If it’s below the $100, you’ve cut into your profits!

Wait just a minute… That’s not what you intended to do.

Here are the correct calculations:

Your targeted profit % is 40; Take 100 minus 40% and you get 60%. (100 – 40% = 60%) Take your cost of $100 divided by 60% (or .60 which is just another way to write 60%) and you get $166.67. That would be the correct retail price to assign.

You can then double check to ensure you have your 40% profit margin by:

Take your set retail price of $166.67 and subtract your targeted profit %. ($166.67 – 40% = $100.) NOW THAT’S A 40% PROFIT MARGIN!

Simple math, but usually a bit misunderstood. You need to practice it until you can arrive easily at any profit margin you wish. If you want a 30% profit, divide the cost by .70. If you want a 60% profit, divide the cost by .40. If you want a 20% profit, divide the cost by .80, etc.

Hope this brings you better profit margins!

Craig Ferreira/CEO

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