Posts Tagged ‘Gross margin’

Profit Margins and Volume

April 9, 2012

First, congratulations to Bubba Watson, Masters Champion.

Your Unit sales volume means a great deal.  Why? because it determines what your Unit Costs are.  These costs must be covered in the price you charge.  Your profit margin must cover unit costs in order to break even.  In the following example, the owners salary is considered a fixed cost.  For this example, too, imagine you sell only one item –> cups of coffee,  and your costs are:

1. $60,000 – Your Salary (always first on the list, for this is why you are in business).

2. $15,000 – Rent

3. $75,000 – Total Fixed Costs (I added the term Fixed, that is, they don’t vary no matter what your volume is.)

Now suppose two scenario’s.  First, you sell 1000 items per month.  Second, you sell 5,000 items per month.

Annual volume is therefore, 12,000 units in the first scenario, and 60,000 units in the second.

You can now calculate what your unit costs will be:

A. – $75,000/12,000 = $6.25 cents per unit in scenario one, and

B. – $75,000/60,000 = $1.25 per item in scenario two.

Now, if the cost of materials for a cup of coffee are: Cup – $.10; coffee – $.20; and other stuff – $.20, then the cost of materials is $.50 for each cup sold.

Let’s further assume your desired profit is $30,000 per year, or $2.50 per item at the 12,000 volume level, and $.50 if your volume is 60,000 units per year.  It is now easy to calculate your price.

Column1 Scenario 1 Scenario 2
Volume 12,000 60,000
Fixed Costs $75,000 $75,000
Unit fixed Costs $6.25 $1.25
Cost of Goods $0.50 $0.50
Desired Profit $2.50 $0.50
Price Must be $9.25 $2.25

Remember: Total Costs + desired profits/ volume = the price you must charge.