I was working with a client on tracking his sales and profitability when I helped him uncover over $15000. He had been making a simple math mistake – He was assuming that if he marked up his product by 35%, then his profit would be 35%. All of his research said you should shoot to have a profit margin of 35% to make money for covering overhead. Makes sense, right? Let’s go through the math for determining selling price:
Purchase price $1.00
Markup percent 35%
Selling Price $1.35
A quick math shortcut here is to add 1 plus the markup percent times the purchase price (1.35 in our example) to come up with 1.35 times purchase price = Selling price. We will use this number a little later.
With me so far? Good! Here’s where things got a little tricky: When he was working on his budget, he was pretty good at estimating sales, so to figure out his cost of goods sold, he simply took the estimated sales for May and said if I have $10,000 sales, my profit margin should be 35% of $10,000 or $3,500 (gross profit) to cover expenses. Problem is, he was losing money, and the check book balance backed it up…
Here’s where the math blew up. If you have $10,000 in sales, then you would need to divide by 1.35 to come up with a cost of goods sold of $7,407 and a gross profit of $2,592.59, not $3,500, a difference of $907 and change. In reality, it was a profit margin of 25%, not 35%. While it may not sound like a big difference, a math parlor trick of sorts, increasing the markup percentage so he could hit the goal of 35% profit margin ended up putting over $15,000 in the check book over the next year. All for changing the way he was pricing!