What Is a Pricing Margin? (2024)

For a small business that sells products, pricing margin is a major factor in the success of a business. As the owner, you want to earn as much margin as possible, but you also need to price your products at a competitive level. The first step when setting margins is to understand how margin is calculated and the difference between margin and price markup.

Price Margin Definition

The pricing margin, more commonly known as the profit margin, on any product you sell is the difference between your cost and the price at which you sell the product to your customers, explains AccountingTools. As a simple example, you buy an item for ​$5​ and sell it in your business for ​$10​. The price margin is the same as your profit margin; in this case ​$5​. You must set a price margin for every product you sell.

Determining your pricing margins is the first step to determine how profitable your business can be. When doing so, it's important to consider all of the costs that go into making and selling your product, including overhead, points out the Corporate Finance Institute.

Profit Margin Percentage

It is very useful to convert the dollar amounts of your profit margin pricing to a margin percentage. For the ​$10​ product that cost ​$5​, the margin is 50 percent. The math for margin percentage is the difference between the price and the cost divided by the selling price. Pricing margin percentage allows you to set uniform profit margins on products with different costs or to set margins by the type of product. Using percentages also allows you to calculate an average profit margin for all of the products you sell.

The reason it's important to know your margin percentages is that it will help you determine which of your products is truly more profitable than others. For example, if you make a red widget for ​$1​ and sell it for ​$1.50​, you make a 50 cent profit per widget. If you make a blue widget for 25 cents and sell if for 50 cents, you only make a 25 cent profit per widget. However, red widgets only give you a 50 percent return on your investment, while blue widgets give you a 100 percent ROI. So, if you spend ​$1​ making blue widgets, you'll make a ​$1​ profit, or twice what you would selling red widgets.

Understanding profit margin percentages and ROI will help you create the best markup formula for your products and services.

Margin vs. Markup

While the pricing margin is the portion of a products selling price that is your profit on that product, markup is how much you add to the cost of a product to get your selling price. In dollar terms, the amount will be the same, but the percentages of margin and markup are very different. The markup percentage calculation divides the difference between cost and selling price by the cost. For the item with a ​$5​ cost and ​$10​ price, the markup is 100 percent, producing a 50 percent profit margin.

Calculating Price From Margin

One practice companies use to set prices is to create a markup formula that creates a margin calculator they can use for each product. For examples, many restaurants use a food-cost percentage to create and set menu item prices. A low-end breakfast eatery might limit food costs to 15 to 18 percent of a menu price. A high-end seafood restaurant might set a limit of 35 to 40 percent of a ticket going to cover the cost of the food.

To calculate a price to get a specific profit margin, divide the cost by one minus the profit margin percentage. So to have a 40 percent profit margin, the cost would be divided by one minus 0.40 or 0.60. From a ​$10​ cost, a 40 percent profit margin would require a selling price of ​$16.67​. While pricing margin is the important margin for your business results, it may be easier to calculate prices using a markup percentage. Develop a table or spreadsheet with a corresponding markup for each profit margin percentage you use in your product pricing.

References