Price, margin and profit: three concepts that are not the same thing
Confusing price, margin and profit leads to poor decisions about the business.
Short answer: price is the amount charged to the customer; margin is the part of the price left after the costs tied to the product; profit is what is left at the end, after all of the business's expenses. They are three different numbers, and each answers a different question.
Why they get mixed up
In everyday talk, it is common to hear "I have a 50% profit" when the person means the price is double the product's cost. That ignores rent, taxes, time and other expenses. The confusion leads to prices that are too low and to the impression that the business is doing well when it is not.
Each concept in one sentence
- Price: how much the customer pays.
- Margin: price minus the direct cost of the product, usually expressed as a percentage of the price.
- Profit: total revenue minus all costs and expenses for the period.
An example
A shop sells a T-shirt for $80, and it costs $40 to buy. The gross margin is $40, or 50% of the price. If, in a month, the shop sells 100 T-shirts, the margin adds up to $4,000. But if fixed expenses such as rent, power and salaries add up to $4,500, the result for the month is a loss of $500, even with "50% margin". This is an illustrative example.
How to apply it
- Use price to compare with competitors and with what the customer will accept paying.
- Use margin to decide which products deserve more space and effort.
- Use profit to know whether the business as a whole sustains itself.
Conclusion
Looking at only one of the three numbers gives an incomplete picture. The useful question is: after paying for everything, what is left, and is it worth the effort?
