A Huge Pricing Mistake - Short #93

Many contractors make a huge pricing mistake: confusing markup with margin. The distinction between those two things can be the difference between being profitable and losing it all.

If you want to mark up something that costs $10 by 50%, you multiply it by 1.5 to get $15. So, did we make a 50% gross margin? No; we only made $5 on a $10 transaction; if we take 10/15, we get o.66. So, we really only made a 33% gross margin.

When we factor overhead in, 33% is normally nowhere near enough. Not everything in the business will make money, and those costs become overhead costs. Businesses need to buy vehicles, pay for utilities, and save for emergencies, so you need a net profit from your sales to get enough money to pay or save money for those things. A good business makes 10+% net profit. If you don't do the math properly, you probably won't make that amount of money.

If you use a 40% markup in cases where you have 30% overhead, you won't make enough money. If we have $70,000 in revenue and multiply it by 1.3, you won't get $100,000. Instead, you take the cost of goods sold and divide the number you're charging for by the cost of goods sold. 70,000/0.7 will get you $100,000, which accounts for what you need to earn to break even with 30% overhead. So, for a 10% profit, you'd divide 70,000 by 0.6 (30% overhead and 10% profit).

So, using markup to set prices is a huge pricing mistake. The margins are where you really need to look. ("Margin" also sounds a bit better than "markup.")

 

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