I’ve been recently asked a few times about the difference between margin and markup, so I thought about writing a blog post about it in order to clear out any confusion around those two terms.
Margin and markup are two different ways of looking at your profit on a sale as they both focus on the same amount of money – the difference between your buying and selling prices. However, they show different information. And understanding that difference between margin and markup is essential to ensure your business charges the correct price, and doesn’t miss out on lost profit.
What is margin
Margin (or gross margin) is how much profit you get from a sale, in other words, it refers to sales minus the cost of goods sold (COGS). It is usually calculated as a percentage.
What is markup
Markup refers to the amount by which the cost price of a product is increased to determine the selling price. Markup is added to the cost to cover for profit and overhead expenses (costs necessary to keep the business running on a daily bases – eg staff, fees, equipment costs etc) of the company. It is also usually calculated as a percentage.Or another example – if a particular product has direct costs of $60, a markup of $30 (50%) leads to the selling price of $90.
Which is better – margin or markup?
Confusing margin and markup can often lead to multiple accounting and sales errors – it can lead to either under- or overpricing your products or services, resulting in lost sales or lost profits over time and in some cases, also a cash flow crisis.A common mistake I see a lot of clients making is using markup incorrectly when wanting to achieve a particular margin. A 50% markup will not give you a 50% margin. As a general rule, if you want to have a certain profit margin on your product or service, your markup percentage needs to be higher than your margin.
Let’s look at another example. Say you have a product that costs you $100, and you are wanting a profit margin of $80 (ie you want to earn $80 after deducting all your costs). So you would need to sell your product/service for $180. As a percentage, your margin will be ($180-$100)/$180=44.4%. But your markup will be ($180-$100)/$100=80%
When to use markup vs margin
To determine a selling price to achieve a certain profit, you should use the markup percentage. However, if you’re looking at performance and predict profitability, you’ll want to look at margins of past sales.
Choosing a markup percentage can be complicated – you also should take into account various factors including operation costs, distribution, marketing etc. However, as a general rule, you should markup your products high enough that you will make a reasonable profit on sales after all overheads are accounted for, while also maintaining prices that your customers are willing to pay and that are competitive.
If you need help with understanding margin and markup, how to apply it for your products and services, and creating effective strategies for greater profitability in your business, get in touch with us today.