#UnderstandingProfitMargins #ProfitMarginExplanation #HowToCalculateProfitMargin
Hey everyone,
It seems like you and your coworkers are in a bit of a pickle with this 42% profit margin calculation. Don’t worry, I’m here to help clear up the confusion for you! 🧠
Let’s break it down step by step:
##Understanding Profit Margins
Before we dive into the formulas, let’s make sure we’re all on the same page about what profit margins are and why they’re important.
– A profit margin is a percentage that shows how much profit a company makes on each sale.
– It’s a crucial metric for evaluating a company’s profitability and financial health.
– A higher profit margin indicates that a company is more efficient at generating profits.
##The Formulas
Now, let’s address the two formulas you’ve come across and figure out which one is the correct one to use for your 42% profit margin calculations.
###Option 1: Cost * 1.42
This formula suggests that you take the cost of the item and multiply it by 1.42 to arrive at the selling price with a 42% profit margin.
####Example:
– Cost: $8.25
– Calculation: 8.25 * 1.42 = 11.715
– Rounded: $11.72
###Option 2: Cost / 0.58
This formula suggests that you divide the cost of the item by 0.58 to arrive at the selling price with a 42% profit margin.
####Example:
– Cost: $8.25
– Calculation: 8.25 / 0.58 = 14.224
– Rounded: $14.25
##The Correct Formula
After taking a closer look at both options, it’s clear that the first formula (Cost * 1.42) is the correct one to use for calculating a 42% profit margin. Here’s why:
– The first formula is based on the concept of adding the profit margin to the cost, which aligns with how profit margins are typically calculated.
– The second formula, on the other hand, uses a divisor of 0.58, which doesn’t directly relate to the concept of profit margins.
##Why It Matters
Understanding the correct formula for calculating profit margins is crucial for your job and business. Using the wrong formula could lead to pricing items incorrectly, and that can have a significant impact on your company’s profitability.
By using the Cost * 1.42 formula, you can ensure that you’re accurately pricing items to achieve the desired 42% profit margin.
##Conclusion
In conclusion, when it comes to calculating a 42% profit margin, the Cost * 1.42 formula is the way to go. It’s essential to have a clear understanding of this concept to make informed pricing decisions and contribute to your company’s success.
I hope this explanation has helped clear up the confusion for you and your coworkers! If you have any more questions or need further clarification, feel free to ask. Good luck with your pricing decisions! 💰
Option 2 fits better with how profit margin or portability is actually calculated for businesses (profit/ revenue)
Option 1 seems more intuitive when giving somebody items at a defined cost price and asking them to add a 42% ~~margin~~ mark-up for profits.
If asking the manager is not an option, I would just go with option 2.
Edit: for completeness and technical correctness, even option 2 is just a gross margin. Also option 1 is sometimes (confusingly) framed as profit percentage. Best thing to do would be just ask the manager for clarification.
Profit margin is the percent of revenue left over after you subtract costs, so you need 42% of the total sell price (option 2).
Margin is applied to the final price – so it’s not 42% of cost (A) but of price (B)
If u sell something for $100, u want $42 profit (42% of $100).
This means the rest is cost i.e. $58
What is the price u want for something that costs $58? It’s $100 which is $58/0.58
Tip – use $100 when trying to understand percentages. It helps keep things intuitive.
Option 2 is undoubtedly what was meant.
If customer spends $1, then $0.42 will be “margin” and $0.58 will be cost.
You’re confusing yourself by conflating Markup Percentage (Option 1) with Profit Margin Percentage (Option 2). Profit margin tells you what percentage of the sales price was profit. Markup percentage tells you how much you added to the purchase price. They’re not the same thing, which is why you get different answers when you use your two different methods.
Option 2 is correct, assuming all your figures are straightforward and your manager is only asking that you calculate the profit margin based on selling price and purchase price (which is the standard way to do it for frontline employees).
Profit margin is (Revenue – Cost) divided by Revenue. If you do the algebra, you eventually end up with that formula:
Revenue = Cost divided by (1 minus desired margin). So plugging in your values, you indeed end up with $14.25 as your selling price if the purchase cost of the item was $8.25.
As someone else said, Option 2 is giving you the gross profit margin. That’s what happens when you simply use the purchase cost of the item as the total cost. If you want to know how your company arrived at that number, they essentially calculated backwards to figure out where they needed to set it using Net Profit Margin. That figure would use ALL aspects of cost, including labor, electricity, building overhead, etc. Accounting likely factored those numbers in and plugged in a few different values for Gross Margin until the Net Margin number matched up with what they wanted it to be.
Let’s make things easier by using some nice round numbers:
> **Option-1:** Cost: $10, Markup:50%, MSRP: $15
> **Option-2:** Cost: $10, MSRP: $20, Margin: 50%
Option-1 represents a 50% *markup*; the amount of profit here is calculated as 50%-of-cost added over the base cost.
Option-2 represents a 50% *margin*; the amount of profit here is calculated as 50%-of-final-price.
If cost is 8.25 and you are selling it for 14.23 retail(I don’t know why you rounded 14.22 to 14.25), then you have 72.48 % profit. To get the profit from cost, subtract the cost from the retail. So 14.23 – 8.25 = 5.98. Now divide 5.98 from 8.25, and you get 72.484848~.
So, the first one is correct. Since you want 42% profit from the sale, you need to add 42% on top of the cost. So 8.25 * .42 = 3.465. 3.465 + 8.25 = 11.715
Option 1 is a 42% markup.
Option 2 is a 42% margin.
There is a significant difference in markup v margin.
Alright my friend. I know this
One is margin and one is markup
Markup: cost X (1+ markup amount)
Margin: cost / (1- margin amount)
Option 2 is a 42% profit margin.
Option 1 is a 42% markup, which creates a profit margin of ~30%, which may be the ultimate goal of the policy.
I think the word you’re actually looking for is markup. Profit “margin,” is after wages, rent, utilities, and everything else is baked in to the prices. It doesn’t seem like you are involved in that part. Retail profits would typically be 10-20%, which in this case requires a markup of 42%
So there’s 2 different terms that people in the comments seem to be getting mixed up, which are Margin and Mark-up. Let’s look at examples for both, imagining an item that cost £100.
Mark-up: That is 42% of the cost added on, ie the sales value is 142% of the cost. Therefore this would sell for £100*1.42 = £142
Margin: This is where the cost is 58% of the sales price. Therefore, this would sell for £100/0.58 = £172.
By your example, if you sell items based on a 42% margin then your Option 2 is right
Be careful with your language. They cannot be both identified as markup. Option 1 is a markup calculation, while option 2 is margin.
Good question but the answer is simple. The key here is to understand two words: Markup and Margin.
These are same in absolute values but different when expressed as percent.
So in your case above, Option1 is Markup and Option2 is Margin.
So if your company is asking for a 42 PERCENT margin (and the key word here is “PERCENT”), then option2 is correct.
For a reference, here is a website explaining the same:
https://www.investopedia.com/ask/answers/102714/whats-difference-between-profit-margin-and-markup.asp#:~:text=Key%20Takeaways-,Profit%20margin%20and%20markup%20are%20separate%20accounting%20terms%20that%20use,a%20product%20minus%20its%20cost.
To go from 100% price to 58% cost
Cost = Price x 0.58
.
To go from 58% cost back to 100% price do the opposite (inverse)
Price = Cost / 0.58
.
We had a job get priced the other week for a 124% margin. I took far too long to explain to the sales team how that doesn’t math.
You can also think of this visually. A “margin” is the added padding (why it’s called margin) to the cost. A 42% margin means of the whole sales price, 42% of the price is the margin and 58% is the cost.
$8.25 $6.00
|—– cost ——|— margin —|
58% 42%
EDIT: Formatting for mobile
A 1% profit margin is very small. From 100$ in revenue you pay 99$ in costs and take home only 1$. Think Walmart.
A 99% profit margin is very high. From 100$ in revenue you pay 1$ in costs and take home 99$ in profit. Think IT consultancy.
Note that no matter what anyone says in this thread, the only person who can answer this is your boss. You REALLY should check with them before doing it the wrong way and needing to redo hours (or days!) of work.
Your boss could be conflating terms.
I love this website. There are so many calculations I do on a regular basis, I can’t remember them all. I always double check my formula here.
https://www.calculatorsoup.com/calculators/financial/index-sales-calculators.php
Plus this calculator
https://www.calculatorsoup.com/calculators/algebra/percentage-increase-calculator.php
>Option 1:>Cost * 1.42 = (item at 42% margin)
>
>Ex: 8.25 * 1.42 = 11.715 -> $11.72
In this case, .42 is your profit out of 1.42.
0.42 / 1.42 = 29.6% profit margin
You just illustrated the difference between markup and margin. Mark up is option 1 and margin is option 2.
To apply a margin you just divide your cost by (1-margin%)
E.g. cost of 100 with a margin of 42% is 100/0.58 = 172.4
To check – 172.4-100 = 72.4. A nominal gross profit margin of 72.4.
72.4/172.4 = 42% gross profit margin
Edit: don’t conflate mark-up with margin.
Mark-up applies a % increase to your underlying cost. (E.g a 50% mark up is just a charge price of cost+50%)
A margin is the difference between sale price and cost price. The same value as above (50% mark up) is a 33.3% margin.
2 is margin. Margin a a function of retail pricing
Number 1 is markup which is a function of cost.
I believe Option 2 has a rounding typo
8.25 / .58 = 14.224 -> **$14.25**
Should be
8.25 / .58 = 14.224 -> **$14.22**
Not a big deal but took me a minute….
Option 2 actually has 42% as profit, whereas as a result of option 1 using original cost + 42%, profit is less than 42% (29.6% in this case).
When talking percentages, you always have to keep in mind what you’re taking a percentage of. What is the value of the 100%? If 100% is the final price, then the increase is the profit margin. If 100% is the original cost, then the increase is the markup.
If you have 4 quarters and you take one away you’ve just removed 25% if you have 4 quarters and you add a 5th quarter you’ve added 20%
Always best to work through a math problem from the core out in my opinion.
What is profit margin? It is how much money you have left over after subtracting expenses from revenue, expressed as a percentage of the revenue.
So, Profit = Revenue – Expense
And to express that as a percentage of the revenue you simply divide by the revenue
So, Profit Margin = Profit / Revenue
Or, Profit Margin = (Revenue – Expense) / Revenue
In your case, you know what the profit margin, and you will presumably know the cost too, but you don’t know what price to charge. So you can rearrange to solve for the Revenue
So, PM = (R-E)/R
becomes, PM = 1 – E/R
Then, 1 – PM = E/R
Then, R = E/(1 – PM)
Which is Option #2 from your post.
I know this was a long comment for a simple question but hope it helps for future problems too!
Markup and margin are totally different calculations.
i.e. RRP is $100 and you get 50% discount, your margin is 50%.
However, your markup needs to be 100% to sell at the RRP.
Example 2 RRP is $100 and you get 42% discount, your margin is 42%.
However, your markup needs to be ~72.4% to sell at the RRP.
​
Best tool is a gross profit calculator. You can put your cost in and your margin and it will calculate your sell price for you. Plenty of options in the app store. I’m more surprised you’ve been told you have to do this and not been given clear instructions on the difference between markup and margin.
Option 1 is call mark-up aka a 42% mark-up.
When you’re talking about margin, the number is the percentage of the final price. So to give an example:
Let’s say we are selling an item that costs us $80 but we want to see 20% margin:
Option 1 would total 89.6 – this isn’t even 10% margin and we’re probably losing money in this case
Option 2 would total 100 – of which $20 (20%)is our margin.
Subsequently in this case, we had to mark up by 25% to see a 20% margin.
(Price – cost) / price = margin
(Price / price ) – (cost / price ) = margin
1 – (cost / price) = margin
1 – margin = cost / price
Price = cost / ( 1 – margin)
This one is going to get buried because its late but think of it this way: every $100 sale has to have $42 of profit and so $58 of cost.
$58 * 1.42 = $82.36 sale price, $24.36 profit.
$58 / 0.58 = $100 sale price, $42 profit.