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- Calculate your gross margin and net margin
- Set your sales price using the markup calculation to cover costs and earn a profit
- Calculate your business's breakeven point and start turning a profit
ImportantReview your financial statements regularly to check your margin, markup and breakeven calculations are still correct. Doing this check provides a good way to spot any increase in expenses so you avoid losing money.
Enter your sales and expenses information into our Financial Statements template to calculate your margin, markup and breakeven figures within the profit and loss, balance sheet or cash flow statements.
Calculating your price of goods to earn a profit
There are two margins that need to be considered when monitoring your profitability: gross margin and net margin. Knowing these figures helps to set prices for goods and to calculate your sales targets. Figures used in the examples below are included in the example Profit and loss statement within our Financial Statements template.
Gross margin is money left after subtracting the cost of the goods sold from the net sales and can be a dollar value (gross profit) or a percentage value.
Net sales are the total value of sales for a given period less any discounts given to customers and commissions paid to sales representatives.
Gross margin is not commonly used for service businesses as they usually don't have cost of goods.
Gross Profit (dollar value) = Net Sales less Cost of Goods Sold
Gross Margin (percentage value) = (Gross Profit dollars / Net Sales dollars) x 100
Gross Profit: $52,000 - $31,200 = $20,800
Gross margin: $20,800/$52,000 x 100 = 40%
Using the example figures Joe's Motorbike Tyres has a gross profit of $20,800. The business's overhead expenses must be less than this to earn a profit.
Once you have your gross margin you can calculate your net margin.
Net margin is your profit before you pay any tax (tax is not included because tax rates and tax liabilities vary from business to business). Net margin is your gross margin less your business overhead expenses.
Net Margin can be calculated as follows:
Net Profit (dollar value) = Net Sales less total of both Cost of Goods Sold and Overhead Expenses
Net Profit (dollar value) = Gross Profit less Overhead Expenses
Net Margin (percentage Value) = (Net Profit dollars / Net Sales dollars) x 100
Net profit: $20,800 - $15,600 = $5,200
Net margin: $5,200/$52,000 x 100 = 10%
If the net margin is 10 percent then for every dollar of goods sold you will make 10 cents in profit before tax after all the cost of goods and overhead expenses have been paid.
Using the example figures Joe's Motorbike Tyres will earn 10 percent of $52, or $5.20, from every tyre sold.
Markup is the amount of money above the cost of purchase or manufacture you sell your goods for. The price of goods sold needs to cover the cost of goods plus overhead expenses and allow for profit to be earned.
Markup is generally used when referring to the sale of products rather than services.
Markup is calculated as follows:
Markup percentage value = (Sales less Cost of Goods Sold / Cost of Goods Sold) x 100
Markup percentage value = (Gross Profit/Cost of Goods Sold) x 100
66.67% = ($52,000 - $31,200/$31,200) x 100
Using the example figures Joe's Motorbike Tyres' markup percentage is 66.67%.
To reach the gross profit of $20,800 by selling motorbike tyres bought for $31.20, Joe will multiply his unit cost price by the markup percentage ($31.20 x 1.6667 = $52 ).
Each tyre will have a minimum price of $52 each to earn enough money to cover business expenses.
Calculating your breakeven point
The break even calculation identifies the number of sales to be made, (in dollars or units), before all the business expenses are covered and profit begins. (before tax).
If you know the unit’s sale price and cost price and the business operating expenses you can calculate the number of units you need to sell before you start making a profit.
Breakeven analysis is helpful information when preparing and updating your business plan and can be used to set sales targets.
Use the following simple calculation to find where profit really starts:
Breakeven dollar value needed before net profit = Overhead expenses/ (1 – (Cost of Goods Sold / Total Sales))
Breakeven number of units to be sold before net profit = Overhead expenses / (Unit selling price – unit cost to produce)
Breakeven dollar value: $15,600/(1-($31,200/$52,000)) = $39,000
Breakeven number of units to sell: $15,600/($52-$31.20) = 750
Joe's Motorbike Tyres will need to sell $39,000 worth of stock or 750 units before the business earns any profit (before tax).