When you start a business, pricing your product is challenging but an important decision. You want to choose a price that the market will bear but also gives you a good profit margin. Thus, your price will depend partly on your cost to acquire the product, which is your cost of goods sold (COGS).
A markup is an amount you mark up your product from your COGS to cover costs and make a profit.
If you’re in an industry where a 20% markup is standard, you’ll need to know how to calculate it. In this guide, you’ll learn how to do so and what else to consider when setting your prices, including:
How To Calculate A 20% Markup
Calculating a markup is very straightforward.
The markup formula is cost of goods sold (COGS) x the percentage markup you want = the dollar amount of the markup.
Then you’ll add the COGS + the dollar amount of the markup = your price.
If your cost of goods sold is $10 per unit and you want to use a markup of 20%, using the markup formula, you’ll take $10 x 20% or .20 = $2.00. Therefore, your price is $10 + $2 = $12.
As you can see, calculating a markup is pretty simple – but not so fast! You have other things to consider before determining your prices to be competitive in your sector.
Industry Standards and Market Prices
First, most products have a “typical” markup in the industry. You’ll need to determine your product’s industry-standard markup. Usually, you can simply do a Google search to find out what average markups are in your industry.
Many products are sold at significantly higher than 20% markups, while some have a lower markup. But you also have to consider market prices for your product, meaning the prices other companies charge for similar products.
The challenge for startups often comes because they cannot afford to order large inventory. The wholesale prices of most products go down when you buy larger quantities. Therefore, if you purchase small amounts of inventory at higher prices than larger businesses, using the industry average markup may give you a higher price than market prices.
That means you’ll likely need to lower your markup until you can purchase larger quantities to reduce your COGS. If you don’t, and your prices are higher than market prices, you will unlikely find many buyers.
Gross and Net Profit Margin
Using a 20% markup, your gross profit margin is 20%. Gross margin is calculated by subtracting your COGS from your sales price and dividing that by your sales price.
So, using the same example above:
- Your gross profit margin would be ($12 – $10)/$10 = 20%
However, that 20% is not your net profit, which you keep in your pocket.
Net Profit Margin Calculation
Your net profit considers all your other business expenses, including:
- overheads (workplace rent, utilities, office supplies, technology and accounting costs, and more)
- labor wages
- marketing and other expenses
Once you deduct all your expenses, you’ll get your net profit before tax, and with it, you can then calculate your net profit margin, which is done by using the total sales minus COGS minus other expenses divided by total sales.
With $12,000 in total monthly sales, your COGS would be $10,000. Say your other costs for the month are $1,000. Your net profit would be $1,000.
Your net profit margin is:
- ($12,000 – $10,000 – $1,000)/$12,000 = 8.33%
You would break even if your other monthly expenses are $2,000. If they’re more than $2,000, you’ll lose money and have a negative net profit margin.
You can use these numbers and margins to determine how much you need to sell to break even and make the profit you aim for.
Is Your Company Viable?
Once you’ve made these calculations, you’ll need to ask yourself a painful question – is my company viable?
Most startups don’t make money, i.e., a profit for up to 18 months. New businesses either don’t sell enough or their COGS is too high. As mentioned above, a high cost of goods sold can occur due to purchasing low inventory quantities.
The opportunity is to get investment, i.e., a business loan to buy larger quantities or wait until revenue grows – hence the time it takes for startups to reach profitability. Many businesses fail because they do not have enough capital to make those investments while paying all the company’s other expenses.
When launching a startup, it’s important to have a growth strategy. This may involve investing in the company’s growth or seeking funding.
To determine the best approach, it’s essential to project sales based on the investment in growth strategies. This will help identify when the company can reach a breakeven point and generate profits. By carefully planning and executing growth strategies, startups can position themselves for long-term success.
Create a Business Plan
If you need to seek funding to grow your company, you’ll need a solid business plan to present to lenders or investors that justifies putting money into the company to achieve your growth goals. Your business plan will need to include the following:
- Executive summary – highlights the key points of your business plan
- Company summary – your history thus far, as well as your mission and vision
- Description of your products – including your pricing strategy
- Market analysis – includes the size and growth potential of your industry
- Competitor analysis – includes your competitive advantage (USP)
- Sales and marketing strategy
- Operations plan
- Summary of your company management and personnel
- Financial projections
Business plans are also working documents for you to use as a guide to staying the course. Ensure your plan is current and detailed enough to back up any claims or assumptions that lenders may question.
While calculating a 20% markup or any markup may seem straightforward, it’s essential to consider other factors when developing a pricing strategy.
A comprehensive plan is necessary for presenting to lenders or investors and projecting when and how your company can achieve success.
To reach your goals, you must have a solid strategy and understand that building a profitable company takes time and effort. So, take the time to develop a plan that considers all aspects of your business and sets you on the path to success.