Grasping the Difference between Markup and Margin

Last Updated: December 3, 2017

Confusing the terms ‘Markup’ & ‘Margin’ when setting prices for your products or services, can have pretty disastrous consequences for your business. Award-winning business coach Shweta Jhajharia explores the terms and demonstrates how to correctly apply them.

difference between markup and margin, how to calculate markup, how to calculate margin
Image Source: StockSnap.io / Photography: Steve Buissinne

To understand the difference between markup and margin is to accept that the primary language of business is numbers, and it’s a language that business owners must understand. Only by the fullest understanding of this language will business owners be able to make the smartest decisions. Misunderstanding of the finer points can have serious consequences.

During our business coaching sessions, I find that many owners are confused about the difference between Markup and Margin. This confusion is particularly marked among owners who are considering discounting their products (which is something that we don’t recommend, but I digress…).

It’s vital for you to realise that there is a difference between markup and margin, and understand what that difference is. Confusion about the difference between markup and margin, mixing or transposing the terms, or thinking that they are the same thing, can result in some pretty significant business losses, so it’s vital for you to fully understand what each term means.

There is a huge range of literature available for studying the basics of accounting, and the top five best-sellers on Amazon alone are worth your time, including Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports by Thomas Ittelson; Accounting All-in-One For Dummies; Mike Piper’s Accounting Made Simple; David Chilton’s The Wealthy Barber; and Dave Ramsey’s Financial Peace.

But for the purposes of this article, I will look only at the difference between Markup and Margin, show you how to calculate each, and demonstrate what can happen when business owners mistake them.

 

 

The Difference Between Markup and Margin

 

1. How to Calculate Markup

Let’s imagine you own a product-based business, and you’re setting the price of your products. If the cost of the goods from your supplier is £100, and you want a Markup (not a margin) of 60 percent, what price will you be selling at? The simple answer is £160.

The simple equation for calculating the marked-up or sale price is, Cost of Goods multiplied by 1 plus Markup Percentage. In other words:

Sale Price = Cost of Goods x (1 + Markup%)

In our example, Cost of Goods is £100 and Markup% is 60 per cent, so that’s:

Sale Price = 100 x (1 + 0.6) = 160

Sale Price = £160

 

 

2. How to Calculate Margin

Turning to Margin, let’s imagine that in order to make a good profit, you want a 60 percent Margin on the products you sell. What will the price be? The equation for calculating the Gross Margin percentage is:

Gross Margin% = (Sale Price – Cost of Goods) / Sale Price

In this equation, ‘Sale Price’ refers to the amount of money the item brings in; the price of the item to your customers, what you are looking for. ‘Cost of Goods’ is the cost required to produce the item. Using our figure for Cost of Goods (£100) from the above example, let’s now work out what price we need to be selling at to achieve a 60 per cent margin.

Gross Margin% = (Sale Price – Cost of Goods) / Sale Price

Rearranging this formula, we have:

Sale Price = Cost of Goods / (1 – Gross Margin%)

Sale Price = 100 / 1 – 60%

Sale Price = 100 / 0.4 = 250

Sale Price = £250

As you can see, for products with a cost to the business of £100 the price you need to sell them at (£250) to achieve a 60 percent Margin is significantly more than that which is calculated by a 60 percent Markup (£160).

 

 

How Markup and Margin Usually Get Confused

After business owners have identified their ‘target person’ or avatar, have an inbound marketing system that’s pulling in leads, and a sales team asking all the right questions, this is the time to consider the margins for the business, and how to increase those margins.

The main problem arises when business owners tend to think: “Okay, I need to achieve a 60 percent margin. So let me markup my prices by 60 percent.” But the examples above show that this does not achieve what you need to achieve.

In fact, in this example, If you mistake the marked-up price for the margin, you will mark up the price by 60 per cent, to give you a price of just £160. This means that your Gross Profit is 160 (price) – 100 (cost), or £60.

However, in this case, the Gross Margin (calculated by dividing the Gross Profit by the Sales Price) is 60/160 = 0.375, or 3.75 percent. Remember…

Gross Margin% = (Sale Price – Cost of Goods) / Sale Price

In our example, a Sales Price of £160 yields a margin of 37.5 per cent, instead of the 60 percent you need to make a good profit.

If you consistently achieve a margin of 37.5 percent instead of 60 percent, I need hardly elaborate on what kind of impact this will have on a typical business.

This is just one example of the kinds of numbers and linguistic terms that business owners need to understand. But it is the one that could make a huge difference.

Learning this language of numbers is not nearly as complicated as most business owners think. When it is explained clearly, you can see it’s a simple process, which can result in a massive impact for you and your business.