A common mistake is to think you are making higher profit margins than you actually are.
Let’s say it costs you $£70 to either buy in or produce what you sell. (This is called COGS which stands for cost of goods sold).
You decide you want to make 30% profit on it.
So you add on 30% of 70 which is 21.
This is called a 30% mark up.
Your GROSS Profit margin is your gross profit (21) divided by your price multiplied by 100.
In this case 21/91 x 100 = 23% NOT 30%.
To make 30% gross profit you actually need to mark up by 21 x (100/70) = $£30.
Now suppose we sell 10,000 of these items.(This is our volume of sales).
Our revenue is now $£ 100 x 10,000 = $£ 1 million.
Our GROSS PROFIT is therefore $£ 30 x 10,000 = $£ 300,000 equals 30%.
But we have overheads such as rent, rates, salaries and wages, utility bills and so forth.
These add up to $£ 150,000.
So now our net operating profit is only $£ 150,000.
We are only actually making 15% Net Margin, (150,000 divided by 1,000,000 x 100%)
What happens if we then decide on a 10% discount?
That won’t make much dent in our profit will it?
How much would our profit fall by?
Price is now $£ 90
Variable cost $£ 70
Volume 100,000 (unless we sell more but it would have to be by a lot)
Revenue $£ 900,000
Gross Profit $£ 200,000 (33% less)
Overheads $£ 150,000
Net or Operating Profit $50,000 (67% reduction)
Question for you; how much extra volume would you need to sell to overcome the reduction in your bottom line operating profit?
The conclusion is you may be making lower profit margins than you realise.
If you reduce your prices, (or fail to raise them each year in line with the market place), you could
completely decimate them!