Price for Profit: Markup, Margin, and Break-Even Explained

You buy a product for ₱800 and sell it for ₱1,000. Have you earned a 25% margin? No. The ₱200 difference is a 25% markup on cost, but a 20% gross margin on sales.

Markup and margin use different denominators. Confusing them can leave a business pricing below its intended return.

I. Use the right calculation

• Markup: gross profit divided by cost. In this example, ₱200 ÷ ₱800 = 25%.
• Gross margin: gross profit divided by selling price. Here, ₱200 ÷ ₱1,000 = 20%.

To target a 25% gross margin on an ₱800 cost, calculate ₱800 ÷ (1 − 25%) = approximately ₱1,066.67. Adding 25% to cost would produce only ₱1,000.

These examples exclude VAT and assume the ₱800 represents the relevant product cost. Establish whether your price and cost figures include recoverable taxes before comparing percentages.

II. Identify what the cost includes

Supplier price alone may omit freight, handling, production labor, packaging, and other relevant amounts. The appropriate financial-reporting treatment follows the applicable framework. Where IAS 2 applies, inventory cost includes qualifying purchase and conversion costs and other costs of bringing inventory to its present location and condition.

For pricing decisions, also consider payment fees, sales commissions, returns, discounts, and delivery costs. These may affect the economics of a sale even when they are not classified as inventory cost in the accounts.

Keep the accounting classification distinct from the management question: what additional costs does this sale create, and what does it contribute toward overhead?

III. Calculate contribution before break-even

Assume a service sells for ₱1,000. Its variable cost is ₱600, giving a ₱400 contribution per service. If monthly fixed costs are ₱80,000, simplified break-even volume is ₱80,000 ÷ ₱400 = 200 services.

At 200 services, the contribution covers those fixed costs; the model shows no profit before any excluded items. It assumes the stated prices and costs hold within that activity range and every unit is sold.

For several products, sales mix matters. You cannot automatically apply one item’s contribution to the entire business. Capacity limits and step increases in staffing or rent can also change the calculation.

IV. Test a discount before offering it

If the ₱1,000 service is discounted to ₱900 while variable cost stays ₱600, contribution falls to ₱300. Covering the same ₱80,000 fixed cost now requires 267 services when rounded up.

A 10% price reduction can require a much larger increase in volume. Ask whether the business can serve the additional customers without increasing costs or reducing quality.

V. Make pricing a review process

1. Define the product and unit. Be consistent about what the customer receives.

2. Verify costs from records. Avoid relying on an old quotation or an incomplete average.

3. Set the objective. Distinguish gross margin, contribution, and final operating profit.

4. Test volume and capacity. Include a realistic downside scenario.

5. Review actual results. Track discounts, returns, delivery costs, and customer demand.

VI. The practical takeaway

Price should reflect cost, demand, capacity, and strategy. Use the correct percentage and a realistic contribution model before deciding that a sale is profitable.

Sources and further reading

• IAS 2: inventories: https://www.ifrs.org/issued-standards/list-of-standards/ias-2-inventories/
• Small business management guidance: https://www.sba.gov/counseling/manage-your-business/

This article provides general accounting and financial management information. Examples are illustrative. The accounting treatment and compliance requirements depend on the entity’s applicable Philippine reporting framework and circumstances.

For help strengthening your reporting and financial management, contact MJM Law & Partners: https://www.mjmlawpartners.com/contact.

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