Calculator
Overview
A popular pricing strategy is to set selling price based on desired gross margin. A common mistake when using this method is to use a markup formula that does not factor in gross margin, giving you a lower selling price than needed, leaving money on the table and hampering revenue and profit growth.
This tool will help you grow by calculating a selling price to achieve a desired gross margin.
Formula
Symbols
- p = selling price
- c = product cost
- m = gross margin margin
Variables
Selling Price
Selling price is the price that a customer pays for a product or service. It is the final price a person pays after any discounts or promotions have been deducted.
Product Cost, or Cost of Goods Sold (COGS)
Product cost, or cost of goods sold, is the total of all costs directly associated with producing the item or service being sold. It includes such things as labor to produce the goods, the raw materials, freight cost to your warehouse, purchase allowances, as well as any factory overhead.
Gross Margin
Gross Margin is defined as net sales less cost of goods sold. It is basically the amount of money a company keeps after the costs of producing the item or service sold.
How to Use the Tool
There are 3 actions that need to take place for you to see the calculated selling price.
- Enter your product cost into the cost input box
- Enter your desired gross margin percent into the gross margin percent input box
- Click the calculate button
Tool Output
When you click calculate you will see the selling price for the selected parameters.
As a bonus, you will also see the selling price for gross margins above and below what you entered, if applicable. These extra data points will help you visualize how much price changes affect gross margin.
Example Calculation
Let us assume you are selling a product that costs you 2.50 and you want to make a gross margin of 40%.
Using our formula above, it would look like the following:
- selling price = 2.50 / (1 - 0.40)
- selling price = 4.17
We can double check the accuracy if we want using a different formula:
- gross margin = gross profit / revenue
- gross margin = (revenue - cost of goods sold) / revenue
- gross margin = (4.17 - 2.50) / 4.17
- gross margin = 0.40 or 40%
Next Steps
Once you know the selling price to meet your gross margin goals, assign the selling price to your product or service.
If you intend to offer promotions that will affect this price, you will want to raise your gross margin target in the tool to give you a higher selling price to offset promotions that will lower the price and gross margin.
Difference Between Markup and Margin
Markup and margin are often thought to be the same thing, but they are very different. It is important when calculating selling price that the correct formula is being used.
The common definition for markup is:
Solving for selling price, we get the following formula:
If we were to assume the same parameters from the example above, but using 40% as mark-up instead of gross margin, the result would be much different using this formula:
- selling price = (2.50) (0.40) + 2.50
- selling price = 3.50
The gross margin on a selling price of 3.50 would be 29%. If we used mark-up, we would fall short of our gross margin target.
Why Using Margin is a Better Way
Using margin to calculate selling price is the best way to manage growth. When using gross margin in the calculation, you are determining selling price that has a direct effect on an important growth metric. Using markup is thus less affective in managing growth.
When to Use This Tool
Use this tool when you want to be sure you are using the correct formula to determine selling price when targeting a specific gross margin. Using this tool is a quick way to do the math, plus calculate several scenarios above and below the target gross margin in case you decide to lower or raise the selling price.
Is This the Best Method of Pricing Products?
Pricing based on product cost is a great method, but has drawbacks. One limitation is that it does not factor in what customers are willing to pay for the item. Another limitation is that it does not factor in competitor prices. Using the margin method might be a good place to start when determining price if you want to achieve a certain gross margin.
What is a Good Average Gross Profit Margin
The average gross margin across the market in the US is 38.44% and for online retail it is 41.54%, according to NYU Stern School of Business. If your gross margin is higher, you are doing better than average.
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