Profit margin is profit divided by revenue, so an item that costs $4 and sells for $10 has a 60% gross margin; to price for a target margin, divide cost by (1 − target margin).
Profit margin is the share of each sale you keep as profit, calculated as profit ÷ revenue. If you sell an item for $10 and it cost you $4, your gross profit is $6 and your gross margin is $6 ÷ $10 = 60%. To set a price that gives a target margin, divide the cost by one minus the margin: for a 60% margin on a $4 item, $4 ÷ (1 − 0.60) = $10. This guide explains the formulas, the difference between margin and markup, and how to use both to price with confidence. The arithmetic is the same in any currency.
The formulas you need
Four numbers cover almost every pricing question a small business has. Revenue is what the customer pays, excluding sales tax. Cost of goods sold (COGS) is what the item itself cost you: stock, ingredients, packaging. Running costs — rent, wages, utilities — are counted separately.
| Measure | Formula | Example ($10 price, $4 cost) |
|---|---|---|
| Gross profit | Revenue − COGS | $10 − $4 = $6 |
| Gross profit margin | Gross profit ÷ revenue | $6 ÷ $10 = 60% |
| Markup | Gross profit ÷ COGS | $6 ÷ $4 = 150% |
| Net profit | Revenue − COGS − running costs | Calculated per period, not per item |
| Net profit margin | Net profit ÷ revenue | See the monthly example below |
Margin and markup describe the same profit from two directions. Margin compares profit to the selling price; markup compares it to the cost. Because the price is always larger than the cost when you make a profit, margin is always the smaller number. A margin can never reach 100%, while a markup can be any size.
Converting between margin and markup
Suppliers and trade guides often talk in markup, while accountants and reports usually talk in margin. Mixing them up is one of the most common pricing mistakes. Two formulas convert one to the other: margin = markup ÷ (1 + markup) and markup = margin ÷ (1 − margin), with both written as decimals.
| Gross margin | Equivalent markup | Price for a $4.00 cost |
|---|---|---|
| 20% | 25% | $5.00 |
| 25% | 33.3% | $5.33 |
| 30% | 42.9% | $5.71 |
| 40% | 66.7% | $6.67 |
| 50% | 100% | $8.00 |
| 60% | 150% | $10.00 |
| 70% | 233.3% | $13.33 |
You can check any figure with the profit margin calculator or work from cost using the markup calculator.
How to price for a target margin
If you know the margin you need, the price follows directly: price = cost ÷ (1 − target margin). Suppose an item costs $4.00 and you want a 65% gross margin. The price is $4.00 ÷ (1 − 0.65) = $4.00 ÷ 0.35 = $11.43. Check it: profit is $11.43 − $4.00 = $7.43, and $7.43 ÷ $11.43 = 65%.
After calculating, round to a price that makes sense for your customers and your market, then recalculate the margin at the rounded price. Price is also shaped by what competitors charge and what customers will pay, so the formula gives you a floor to work from, not the final answer.
Get the cost right first
A margin is only as accurate as the cost behind it. The most frequent error is leaving out small costs that are paid on every sale. Here is a worked example for a café latte, with illustrative figures:
| Component | Working | Cost |
|---|---|---|
| Coffee | 18 g at $0.03 per gram | $0.54 |
| Milk | 250 ml at $1.40 per litre | $0.35 |
| Cup, lid and sleeve | Per unit from supplier invoice | $0.21 |
| Total cost per latte | $1.10 |
At a price of $4.50 before tax, gross profit is $4.50 − $1.10 = $3.40, and gross margin is $3.40 ÷ $4.50 = 75.6%. Leave out the cup and lid, and the margin appears to be 80.2% — a difference that adds up across thousands of cups a year.
Take sales tax out of revenue
Sales tax, VAT or GST collected from customers is not your revenue; you pass it on to the tax authority. If prices include tax, remove it before calculating margin. With a 15% tax included in the $4.50 latte, revenue is $4.50 ÷ 1.15 = $3.91. Gross profit is then $3.91 − $1.10 = $2.81, and the margin is $2.81 ÷ $3.91 = 71.9%, not 75.6%.
From gross margin to net margin
Gross margin tells you whether each item is priced well. Net margin tells you whether the business as a whole makes money after rent, wages, utilities and everything else. Worked example for one month: takings of $30,000, COGS of $10,500 and running expenses of $14,000.
- Gross profit = $30,000 − $10,500 = $19,500. Gross margin = $19,500 ÷ $30,000 = 65%.
- Net profit = $19,500 − $14,000 = $5,500. Net margin = $5,500 ÷ $30,000 = 18.3%.
A strong gross margin with a weak net margin points at running costs. A weak gross margin points at prices, supplier costs or waste. Looking at both tells you where to act. If you want to know how much you must sell just to cover costs, the break-even calculator uses the same numbers.
Why discounts cost more than they look
Discounts come straight out of profit, not out of revenue in general. Take the $10 item that costs $4. At full price you make $6. With a 10% discount the price is $9 and the profit is $5 — the margin falls from 60% to 55.6%, but profit per item falls by 1 ÷ 6 = 16.7%. To earn the same total gross profit, you would need to sell $6 ÷ $5 = 1.2 times as many, or 20% more units. Before running a promotion, check whether it is likely to bring that much extra volume.
A pricing checklist
- List the full cost of each item, including packaging and any per-item fees.
- Decide the gross margin you need for each category.
- Calculate price = cost ÷ (1 − margin), then round sensibly.
- Recalculate the margin at the rounded price, excluding sales tax.
- Review costs whenever a supplier changes prices, and at least every few months.
- Compare actual margin by item against the target, and look into the biggest gaps.
Doing this in SageBizet
SageBizet lets you enter an optional cost price next to each item’s selling price in inventory. With cost prices in place, Insights shows profit by item for any period, so you can see which products carry the business and which only look busy. Expenses are recorded with a category, amount and date, and net profit is shown as takings minus expenses, daily and per period. SageBizet is not accounting or tax software, so use it to understand and manage margins day to day, and keep your formal accounts with your accountant or accounting tool.