Your real margin isn't the price minus what you paid
Between the price on the tag and what you actually keep there are three things: sales tax, properly valued cost and the discounts you gave at the counter. Here's how to work out all three.
Arca6 min read
«I buy it for 250 and sell it for 520, so I make 270.» It's the math everyone does, and it's wrong for three separate reasons that stack on top of each other. Let's take them one at a time with the same example (amounts in Mexican pesos).
One: the tax in that price isn't yours
In Mexico, prices are shown with IVA included: the 16 % value-added tax. If you sell for $520, your revenue isn't $520: it's $448.28, and you're holding $71.72 you collected from the customer on behalf of the tax authority. That money passes through your till, but it's never your sale.
To get the pre-tax amount you divide by 1.16; you don't subtract 16 %. Taking 16 % off $520 gives you $436.80, which is off by almost 12 pesos on every sale.
| Item | Amount |
|---|---|
| Shelf price | $520.00 |
| Revenue before tax (520 ÷ 1.16) | $448.28 |
| IVA collected | $71.72 |
Two: your cost isn't what you paid last time
If you bought ten pieces at $200 and ten at $300, your cost per piece is $250 (the weighted average), not $300. Using the last purchase price would put your margin at 33 % when it's really 44 %, and with that number you might decide to drop the very product that makes you the most.
Three: discounts at the counter
«I let this one go for 480.» That discount comes straight out of your margin: the cost didn't go down, the tax is recalculated on less, and the $40 comes entirely out of what you were going to make. An 8 % discount on a piece with a 44 % margin takes almost a fifth of the profit on that sale.
That's why discounts are recorded line by line, not as one lump reduction at the end: it's the only way to know later which product is being marked down, who's marking it down and what the habit is costing you.
The full picture
| Item | No discount | With $40 off |
|---|---|---|
| Price charged | $520.00 | $480.00 |
| Revenue before tax | $448.28 | $413.79 |
| Average cost | −$250.00 | −$250.00 |
| Gross profit | $198.28 | $163.79 |
| Margin | 44.2 % | 39.6 % |
Margin is calculated on revenue before tax, not on the tax-included price and not on cost. Gross profit divided by revenue: 198.28 ÷ 448.28 = 44.2 %. It's the number that lets you compare products with each other, and the only one you can add up for the whole business.
From gross margin to what you actually keep
Gross margin still isn't your profit. You have to take out rent, payroll, electricity, card fees and everything else you pay whether or not you make a sale. A business with a 44 % gross margin and $61,200 in monthly expenses needs $139,000 in pre-tax sales just to break even.
That's the order to read your numbers in: first the margin per product, to know what to push; then the margin for the business; and last the income statement with expenses included, which is what tells you whether the month was good.
Arca breaks down every sale as you record it: it sets aside the tax, freezes the average cost and stores the discount on its line. From there you get the margin per product, the margin for the period and the income statement, without entering anything twice.
Work out a product's selling price (free)
