Product margin is the profit margin per product. The product margin shows the amount the product sells for above the cost of manufacturing the product. In other terms, product margin is used to determine how much of the products selling fee is a markup. For a company that produces varied products, calculating the product margins of the various products shows which product is bringing in most revenue relative to their cost of production.
Calculating the product margin
Calculating a product’s profit margin begins with the selling price – what customers are charged for it. From this figure, the cost of the product is subtracted. The cost of the product includes the cost of raw materials, processing, assembly costs and labor costs. For companies that don’t manufacture the product, the cost of the product is how much it cost to obtain it; that is, the wholesale price plus shipping and handling. Overhead costs are not included in this calculation. The difference between the selling price and the product cost gives the product’s gross profit margin. To obtain the product margin, the gross profit margin is divided by the selling price.
Product margin= (selling price – cost of product) / selling price.
Product margins are usually expressed in terms of percentages. For instance, take a business that retails motorcycles for $ 1,000 apiece. If it cost the business $650 to obtain the motorcycle, then the gross profit for each motorcycle is ($ 1,000 – $ 650) = $ 350. The product margin is ($ 350 / $ 1,000) = 0.35, or 35%. For each dollar that the owner makes in revenue for selling the motorcycle, he/she gets 35 cents.
Significance of product margin
A company’s individual numbers such as revenue or expenditure don’t tell much about the profitability of the company and the earnings of a company don’t tell the whole story as it is. For example, just because the earnings of a company have increased doesn’t mean that the profitability has increased. This is because although the revenue may have increased, the costs may have increased at a higher rate. Profit margins of a product help show what is behind the numbers and exactly how profitable a company is.
Profit margin vs. profit percentage
Profit margin is not to be confused with profit percentage, which is similar though distant. Unlike the profit margin that takes the selling price or revenue as the base, the profit percentage uses the cost price. Profit percentage shows the percentage of profit to cost.
Profit percentage = (net profit / cost price) X 100