A crucial factor in pragmatic business management is knowledge of gross margin. This term is commonly connected to markup, which compares the price your business receives from selling an item to the cost incurred to obtain the item. Not every business, of course, sells specific items. But all businesses have direct costs that are absolute necessities for delivering sales.
Gross profitability ignores general overhead costs. Those are the operating expenses a business incurs even if nothing is sold, such as rent and telephone service. Direct costs are the necessary expenditures to make a sale happen. These are things like materials and the labor cost for the specific time allocated to complete a sale.
Gross margin, however, is a bit different than gross profit. Margin is a percentage. If you mark up something 1.5 times above your cost, the price you charge is $150 if your costs are $100. Gross margin equals price minus cost divided by price. It’s your markup amount divided by the sales price. Notice that the gross margin in this example is 33.3% ($150 minus $100 divided by $150).
The objective is to maintain a consistent gross margin. How you accomplish this as costs change means adjusting your price. This requires identifying a markup that corresponds with the gross margin you want to maintain. Simply turn around the relationship formula to show that markup is 1 divided by 1 minus gross margin. So if you want to keep a 33.3% margin, you have to markup your costs 1.5 times, that is, 1 divided by 1 minus 0.333.