Margin is how much profit you get from a sale. Or in other words: revenue minus cost of goods. It is usually calculated as a percentage out of revenue.
Margin = (revenue-cost) / (revenue) X100
Margin = (700 – 500) / (700) X 100 = 29%
Markup, on the other hand, is how much the cost of your product is increased in order to get to the selling price. While margin calculates how much money you make on an item in relation to revenue, markup is calculated relative to costs.
Markup = (revenue – cost) / (cost)
Markup = (700 – 500) / (500) X 100 = 40%
For example, if a particular product has direct costs of $500, a markup of $200 (40%) leads to the selling price of $700.
Both profit margin and markup are important concepts that can be used to help you price your products effectively, but it is crucial that you understand the major difference between the two. Misunderstanding how they differ could lead to poor pricing of products, decreased profitability over time and in some cases, a cash flow crisis.
One big mistake a lot of people make is using markup incorrectly when wanting to achieve a particular margin. A 30% markup will not give you a 30% margin. To be clear, if you want to have a certain profit margin on a product, your markup percentage needs to be higher than your margin.
For example, if I have a product which costs me $100 and I want a profit margin of $80 (i.e. I want to earn $80 after minusing my costs) I would need to sell the product for $180. As a percentage, my profit margin will be (180-100)/180 = 44%
On the other hand, my markup will be (180-100)/100 = 80%.
To avoid making costly mistakes, it is good practice to know how to convert your desired margin to the correct markup. To do so, follow the calculation below:
Desired margin / cost of goods = markup percentage
Now if we want to know what price we should sell the product for at our calculated markup we would use the following formula:
Cost of goods X 1.markup percentage = selling price
For our example above, that would mean:
80/100= 80% markup
100 X 180% = $180 selling price
The ideal markup percentage will depend on a number of factors including what your industry is, and any indirect costs that need to be covered. In some industries, the markup percentage is quite low, while in others it can be very high. It’s important to choose the right percentage markup for your unique situation.
If you need assistance with developing effective strategies for greater profitability in your business, get in touch with the team at Lawrence Group. We offer financial services, business planning and support for stronger, healthier businesses, and we would love to help you