What will be the percentage profit after selling an article at a certain price if there is a loss of 45% when the article is sold at one third of the previous selling price?

This is why a retailer is more likely to price a product at $19.99 rather than $20.00.

Customers are more likely to make a purchase when it is $19.99 because our brains tell us — “This is less than $20.00? it’s a bargain.” Other industries tend to use this technique, such as those in real estate. You can try it yourself.

Take the previous price of $62.50. Would $59.95 be the more enticing price that leads to higher profits?

How to find the best pricing strategy

If your pricing strategy and your competitor’s pricing strategy are the same, then it’s like missing out on utilizing a helpful tool.

Like it or not, customers infer a lot of information about your business from your prices. Another thing — the results of price changes are not always linear. For example, a company could raise its prices by 1% and see overall profits increase by far more than that, even if demand remained the same.

The best strategy you can apply is a flexible one.

For example, WTMWB (What the Market Will Bear) is better during short periods when you need to recoup costs quickly, such as releasing a new SKU after a period of R&D. Cost-plus pricing is how to calculate selling price per unit. In contrast, GPMT helps you decide if this approach can scale up.

Once you come up with a suitable price, you can apply most significant digit pricing.

Commit to changing your price for a set minimum time and stick to that plan. Don’t keep changing prices, as this could reduce your customers’ trust in you.

Pricing strategy case study

Let’s use the example of furniture manufacturers to illustrate the steps to finding a pricing strategy.

You know your manufacturing costs and resources spent, but is this enough to add a markup and call it a day? No. Pricing is contingent on the current state of the marketplace and where your products fit into it.

First, you need to understand your market.

Do all the research you can on the criteria of furniture pricing. These could be:

• Direct-to-consumer prices
• Wholesale prices
• Consignment prices
• Any area that deals with selling furniture

You need to figure out how your product fits into the current landscape.

It’s good to set a minimum price that you will not go below. If you think of boundaries like this, it helps you think clearly in the stressful tasks of pricing and negotiation. Don’t undersell yourself or go below your minimum price.

Pricing strategy quickfire tips

1. Have a strategy, and stick to it
2. Use pricing analytics to record market trends and predict future market changes
3. Look at the whole picture, not just on a transaction-by-transaction basis
4. Adopt a value-based approach to customer satisfaction
5. Don’t use a one-size-fits-all approach to pricing. Be adaptable. Create pricing plans and product variations for customers with different needs

Review your financial statements regularly to check your margin, markup and break-even calculations are still correct. Doing this check will help you to spot any increase in expenses so you can avoid losing money unnecessarily.

Use our financial statements template to calculate your margin, markup and break-even figures. Just enter your sales and expenses information into the profit and loss, balance and cash flow sheets.

The template contains example figures for a business called Joe's Tyres. Compare the figures in the template with those listed in the examples that follow on this page.

Calculating your price of goods to earn a profit

There are 2 margins that you need to consider when monitoring the profitability of your business:

Knowing these figures helps you to set prices for goods and work out your sales targets.

What is gross margin?

Gross margin is money left after subtracting the cost of the goods sold (COGS) from the net sales. Net sales is the total value of sales for a given period less any discounts given to customers and commissions paid to sales representatives.

Gross margin can be expressed as a percentage value or as a dollar value (called gross profit).

Gross margin isn't commonly used for service businesses as they usually don't have cost of goods.

How to calculate gross profit and margin

To calculate gross profit (dollar value):

• Gross profit ($) = net sales − COGS

To calculate gross margin (percentage value):

• Gross margin (%) = (gross profit ÷ net sales dollars) × 100

Once you have your gross margin, you can calculate your net margin.

Example: Joe's Tyres

• Gross profit for Joe's Tyres: $52,000 − $31,200 = $20,800
• Gross margin for Joe's Tyres: $20,800 ÷ $52,000 × 100 = 40%

Joe's Tyres has a gross profit of $20,800. The business's overhead expenses must be less than this to earn a profit.

The gross profit and gross margin figures for Joe's Tyres are listed in the example profit and loss sheet of the financial statements template.

What is net margin?

Net margin is your gross margin less your business overhead expenses. It's your profit before you pay tax. Tax isn't included because tax rates and tax liabilities vary from business to business.

Net margin can be expressed as a percentage value or as a dollar value (called net profit).

How to calculate net profit and margin

To calculate net profit (dollar value):

• Net profit ($) = net sales − total of both COGS and overhead expenses
  or
• Net profit ($) = gross profit − overhead expenses

To calculate net margin (percentage value):

• Net margin (%) = (net profit dollars ÷ net sales dollars) × 100

If the net margin is 10%, then for every dollar of goods sold you'll make 10 cents in profit before tax after you've paid COGS and overhead expenses.

Example: Joe's Tyres

• Net profit for Joe's Tyres: $20,800 − $15,600 = $5200
• Net margin for Joe's Tyres: ($5200 ÷ $52,000) × 100 = 10%

Joe's Tyres will earn 10% of $52 (or $5.20) from every tyre sold.

The net profit figures for Joe's Tyres are listed in the example profit and loss sheet of the financial statements template.

What is markup?

Markup is the percentage price that you sell goods for above what it costs you to purchase or manufacture them. The sales price must cover the cost of the goods plus any overhead expenses to allow you to earn profit.

Markup is generally used when referring to the sale of products rather than services.

How to calculate markup

• Markup percentage value = (sales – COGS) ÷ COGS × 100
  or
• Markup percentage value = (gross profit ÷ COGS) × 100

Example: Joe's Tyres

• ($52,000 − $31,200) ÷ $31,200 × 100 = 66.67%

The markup percentage for Joe's Tyres is 66.67%.

To reach the gross profit of $20,800 by selling tyres bought for $31.20, Joe will multiply his unit cost price by the unit cost plus the markup percentage ($31.20 × 1.6667 = $52).

Each tyre will have a minimum price of $52 to earn enough money to cover business expenses.

What is break-even?

The break-even point shows the sales your business needs to make in dollars or units before your expenses are covered and you can start making a profit (before tax).

Break-even analysis is helpful when preparing and updating your business plan. You can use your break-even to set sales targets for yourself or your staff.

How to calculate break-even

Use the following calculations to find where your profits start.

To calculate your break-even (dollar value) before net profit:

• Break-even ($) = overhead expenses ÷ (1 − (COGS ÷ total sales))

If you know the unit's sale price and cost price and the business operating expenses, you can calculate the number of units you need to sell before you start making a profit.

To calculate your break-even (units to sell) before net profit:

• Break-even (units) = overhead expenses ÷ (unit selling price − unit cost to produce)

Example: Joe's Tyres

• Break-even (dollar value) for Joe's Tyres: $15,600 ÷ (1 − ($31,200 ÷ $52,000)) = $39,000
• Break-even (units) for Joe's Tyres: $15,600 ÷ ($52 − $31.20) = 750

Joe's Tyres will need to sell 750 units or $39,000 worth of stock before the business earns any profit (before tax).