Last reviewed: 29 September 2026 · Reviewed by IFM's qualified accountant
Use margin to understand how much of each sales pound remains to cover overhead and profit, and use mark-up carefully as one route from known cost to price. A sustainable price also needs capacity, customer value, VAT and cash considerations.
What should you know about the two formulas?
Gross profit equals selling price less direct cost. Gross margin percentage is gross profit divided by selling price. Mark-up percentage is gross profit divided by direct cost.
With a £100 cost and £150 price, gross profit is £50. Mark-up is 50% because £50 divided by £100 is 50%; margin is 33.3% because £50 divided by £150 is 33.3%.
State whether figures include or exclude VAT. A VAT-registered business normally analyses net revenue and recoverable net cost, while irrecoverable VAT can form part of cost.
What should you know about converting between them?
To turn a desired margin into a price, divide cost by one minus the target margin. A 40% margin on £60 cost requires a £100 selling price: £60 divided by 0.60.
To convert mark-up to margin, divide mark-up by one plus mark-up. A 50% mark-up becomes 33.3% margin.
Use decimal forms in calculations and format only the display. Rounding early can distort high-volume pricing.
What should you know about define direct cost?
Margin is only useful if cost is complete. Include materials, fulfilment, subcontractors, transaction fees, delivery labour and other costs that change directly with the sale under the chosen definition.
For services, delivery labour is often the missing cost. Use realistic productive hours, salary, employer costs and paid non-chargeable time rather than dividing salary by every calendar hour.
For products, include freight, duty, packaging, wastage, returns and marketplace commissions where they are direct to the sale. Document the policy and apply it consistently.
What should you know about contribution versus gross margin?
Contribution subtracts variable costs from revenue and shows what remains to cover fixed costs and profit. It can be more useful for decisions involving spare capacity, channels or incremental orders.
Gross margin follows the business's accounting classification of cost of sales, which may include fixed delivery costs. The two can differ legitimately.
Name the measure. Do not label contribution, project margin and statutory gross margin all simply “margin”.
What should you know about covering overhead and target profit?
Gross profit must cover rent, management, software, insurance, professional fees, marketing, finance and other overhead before net profit exists. A positive gross margin is not proof that the price is profitable overall.
Calculate break-even sales by dividing fixed cost by contribution margin, using consistent periods. Then test whether capacity and market demand make that sales level possible.
Add a return for risk, investment and owner effort. Pricing only to break even leaves no resilience for bad debts, rework or slow periods.
What should you know about capacity changes the cost?
If the business is full, a low-margin job can displace a better one. Price should reflect the opportunity cost of scarce people, machines or delivery slots.
If capacity is genuinely idle and fixed costs are already committed, an incremental contribution decision may differ. But a temporary price should not become the market expectation without controls.
Track utilisation, lead time and overtime alongside margin.
What should you know about discount discipline?
A 10% price discount does not reduce profit by 10%. If a £100 sale has £60 cost and £40 gross profit, cutting price to £90 reduces gross profit to £30 — a 25% fall.
Set approval levels and show sales staff the profit effect. Require an exchange for discounts, such as volume commitment, faster payment, reduced scope or a longer contract.
Measure realised price after discounts, credits and rebates, not list price.
What should you know about vAT and pricing display?
For 2026/27 the standard VAT rate is 20%, the reduced rate 5% and zero rate 0%, depending on the supply. If a VAT-registered business sells to consumers, confirm whether displayed prices must include VAT under consumer-pricing law and model margin on the net amount.
A business approaching the £90,000 compulsory VAT-registration threshold for 2026/27 should consider whether it can add VAT or must absorb it. That commercial effect belongs in forward pricing.
Do not use the Flat Rate Scheme percentage as the customer VAT rate; the business still charges the supply's normal rate.
What should you know about price by segment and offer?
Customers can create different costs through support, payment timing, customisation, delivery location and returns. Segment prices or service levels where the distinction is clear and fair.
Packages can anchor scope and reduce negotiation, but every package needs a cost and capacity model. Define overage, change control and exclusions.
Avoid a single blended margin concealing loss-making products subsidised by stronger ones.
What should you know about review actual results?
Compare quoted cost, actual cost, price, discount and margin by product, project or customer. Investigate rework, scope creep, supplier changes and unbilled time.
Update standard costs regularly and preserve the original quote assumptions. A favourable average can hide a tail of poor work.
Use management accounts to connect margin changes to cash and operating profit.
What should you know about a pricing decision sheet?
Show net price, tax, direct cost, contribution, gross profit, margin, mark-up, capacity use, payment terms and risk. Include a downside case for overrun or cost increase.
Record who approved exceptions and when price will be reviewed. Communicate the value and scope clearly to the customer.
See management information and consultancy for the relevant service page. Use the Deadline Finder for standard first accounts, first confirmation statement and Corporation Tax dates. For VAT, payroll, personal tax and other obligations, check the tax deadlines calendar and your official records.
What should you know about common calculation errors?
Do not divide profit by cost and label the result margin. Do not calculate on a VAT-inclusive selling price while using VAT-exclusive costs.
Include discounts, refunds, commission and delivery costs consistently. Check spreadsheet formulas when costs or prices are negative, zero or entered in a different unit.
What should you know about services and project work?
Estimate delivery hours by role, realistic utilisation and salary plus employer costs. Add subcontractors, travel, software and rework where they arise from the project.
Set change-control terms. Work performed outside scope without a price adjustment can turn a sound quoted margin into a loss.
Review actual time and cost at milestones rather than waiting for project completion.
What should you know about products and channels?
Calculate margin after marketplace fees, freight, duty, packaging, returns and promotions. Separate channel economics where commission or fulfilment differs.
Stock clearance can justify a lower contribution for a defined period, but record the objective and exit date. Permanent discounting may train customers to wait.
What should you know about governance?
Give staff clear authority bands and required evidence for exceptions. Record the price, scope, payment terms and review date in the customer agreement.
Report realised margin by cohort and customer. Use the findings to improve estimates, supplier negotiation and product mix, not simply to criticise the salesperson after delivery.
What should you know about review frequency?
Review volatile input costs monthly and stable services at least quarterly. Trigger an immediate review after a supplier increase, wage change, tax change, channel fee or sustained delivery overrun.
Communicate price changes with notice and a clear value explanation. Update quotes, contracts, billing systems and sales tools on the same effective date.
What should you know about cash and payment terms?
A high margin can still produce weak cash if customers pay slowly or work is funded in advance. Model deposits, staged billing, retention and bad-debt risk.
Price the financing effect of long terms and large stock commitments. Faster payment can justify a controlled discount only after comparing its cost with the cash benefit.
What should you know about final test?
Before approving a price, ask whether it covers direct cost, contributes to overhead, fits capacity and rewards risk. Then check whether the customer proposition supports it.
Keep the calculation and actual outcome. Pricing improves through a disciplined feedback loop, not one perfect formula.
What should you read next?
Management accounts, small-business KPIs and management information services.
What do people also ask about this topic?
What should you know about the two formulas?
Gross profit equals selling price less direct cost. Gross margin percentage is gross profit divided by selling price. Mark-up percentage is gross profit divided by direct cost.
What should you know about converting between them?
To turn a desired margin into a price, divide cost by one minus the target margin. A 40% margin on £60 cost requires a £100 selling price: £60 divided by 0. 60.
What should you know about define direct cost?
Margin is only useful if cost is complete. Include materials, fulfilment, subcontractors, transaction fees, delivery labour and other costs that change directly with the sale under the chosen definition.
What should you know about contribution versus gross margin?
Contribution subtracts variable costs from revenue and shows what remains to cover fixed costs and profit. It can be more useful for decisions involving spare capacity, channels or incremental orders.
Which official sources support this guide?
- https://www.gov.uk/running-a-limited-company/company-and-accounting-records
- https://www.gov.uk/vat-rates
- https://www.gov.uk/vat-registration/when-to-register
General guidance, not advice for your situation.
