(Note: if you need to calculate gross margin scroll down.)
If you want to increase gross margin with a price increase, you should know how gross profit is calculated and assuming a drop in unit sales, how many unit sales are needed to maintain the same gross profit. On the other hand if you’re considering a sale you should know how many additional unit sales are needed to maintain the same gross profit. You need to know how total unit sales can drop (for a price increase) or need to increase (for a price decrease) for gross profit dollars to remain the same. The numbers may surprise you.
Calculate gross profit, a price increase and total unit sales
If you increase your prices and profit margin, how many fewer units can you sell and keep gross profit dollars the same? We’ve calculated it for you in the chart below. Find the current gross margin of your product in the left column, then find the column that shows your price increase. Where the two numbers intersect you’ll see how many fewer units are required for you to sell and maintain the same gross profit dollars.
For example, if you currently have a 40% gross margin, and you are considering a 10% price increase, you can sell 20% fewer units and you will still have the same total gross profit dollars in the end. You’d have to determine if the price elasticity in your market, or your competition, would allow you to have a 10% price increase. In today’s economy many owners and managers are looking for ways to increase revenue and this is one option to consider. You can also look at slower moving items or replacement items as opportunities to increase prices, while keeping your best selling items competitively priced.
|If you increase your prices, how much can unit sales decrease and maintain the same gross profit dollars?|
|Current margin, before a price increase||+5%||+10%||+15%||+20%|
|30% gross margin||-14%||-25%||-33%||-40%|
|35% gross margin||-13%||-22%||-30%||-36%|
|40% gross margin||-11%||-20%||-27%||-33%|
|45% gross margin||-10%||-18%||-25%||-31%|
|50% gross margin||-9%||-17%||-23%||-29%|
copyright 2013 Hedges & Company
Calculate gross margin, a price decrease and total unit sales
If you decrease your prices (a sale or discount coupons, for example), how many more units do you have to sell to keep gross profit dollars the same? We have it for you in the chart below.
Find the gross margin of your product in the left column, then find the column that shows your price decrease. Where the two numbers intersect is a number that shows how many more units you have to sell as a result of a price decrease to maintain the same gross profit dollars.
For example, if you have a 35% margin, and you are considering a 10% price decrease, you must have a whopping 40% increase in unit sales to end up with the same total gross profit dollars. This is important to know if you are considering a sale in an attempt to increase unit sales of a product, especially if it has a low gross margin to begin with.
|If you decrease your prices, how much must unit sales increase to maintain the same gross profit dollars?|
|Current margin, before a price decrease||-5%||-10%||-15%||-20%|
|30% gross margin||+20%||+50%||+100%||+200%|
|35% gross margin||+17%||+40%||+75%||+133%|
|40% gross margin||+14%||+33%||+60%||+100%|
|45% gross margin||+13%||+29%||+50%||+80%|
|50% gross margin||+11%||+25%||+43%||+67%|
|copyright 2013 Hedges & Company|
As you can see, the free market blesses those with high margin. If you have a thin 30% gross margin and you drop your prices 20%, you must triple your unit sales (i.e., increase 200%) to have the same gross profit dollars.
How to Calculate Gross Margin
These examples assume you know how to calculate your gross profit margin. In case you don’t, here’s the calculation. If you sell a widget for $100, and you had to pay $60 for it, your “cost of goods” is 60%, “gross margin” is 40% and you produce $40 in “gross profit dollars” or simply “gross profit.”
The Excel formula for calculating gross profit is this: (Selling Price)-(Cost of Goods)/(Selling Price). In other words, subtract cost of goods from your selling price, which results in gross profit, then divide gross profit by the selling price. Here’s an example: Let’s say you sell a product for $125.95 and your cost is $83.50. That means you generate $42.45 in gross profit for each product sold. $125.95 – $83.00 = $42.95 gross profit. So, $42.95 / $125.95 = 0.341 = 34.1% gross margin.
Another way to look at it is this gross margin formula: Gross Margin = (Revenue – Cost of Goods Sold) / Revenue. Gross margin can be reported on a single unit, or it can be reported on for an entire company. Gross margin for a company would be that company’s total sales, minus cost of goods sold, and divided by the total company sales revenue and usually expressed as a percentage.
If you want to reach a specific gross margin and you know the cost, the “Excel-friendly” math is: (Cost of Goods)/1-(Gross Margin %)=(Selling Price). In other words, if you pay $60 for a widget and want a 40% gross margin, subtract 40% from 1 to get .6, so $60/.6 = $100 selling price. Here’s an example using the same numbers as above. Let’s say your cost on a product is $83.00 and you want to make a 34.1% gross margin. Subtract 0.341 from 1 to get .659, and $83.00 / .659 = $125.95.
Gross Margin or Mark Up?
Note that mark up and gross margin are two different things. “Mark up” defines how much you’re going to add on to a product cost to reach a selling price. “Gross margin” defines how much you make in gross profit at a specific selling price.
As an example of mark up, if your cost for a widget is $60 and you want to sell it for $100, it requires a mark up of 166.66%, or $60 x 166.66% = $60 x 1.6666 = $99.99999 (or simply $100).
For more information see our related article: Read about the Turn/Earn Index.
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