Variation 3—Pricing product to achieve profit margin goals
Now that you have established the gross margin necessary to cover costs and
achieved the desired profit, how can you easily use this information to properly
price products?
The following formula will illustrate this as it applies to the example above:
S - .31S = C
We are saying here that the selling price (S) - .31S = cost of inventory (C)
Hence: S - .31S = C
.69S = C
.69 x $71,014.50 = C
(^) C = $49,000
What we have shown here is that:
If the GM is 31%, the cost of inventory is $49,000/$71,014.50 = .69 or 69% of the
selling price.
Accordingly, if .69 divides a cost price of any inventory item, we will know the
appropriate selling price to yield the desired GM of 31%.
The formula is S = C/.69
The formula presented here is useful in maintaining selling prices at levels
consistent with the levels of GM percentage yield desired. This approach is also
consistent with the way in which to show the financial data on the business
operating statements.
The profit-planning formula is a useful tool in determining what sales are required
to achieve a desired profit goal.