All small businesses like to make money. Many think that margin and markup are the same as they both deal with the cost of goods sold, revenues and the actual amount you make on the sale. This is why margin and markup are so often confused. These two terms are very different. You risk running into serious pricing errors that wipe out your bottom line if you don’t understand the difference and how to correctly calculate each. Markup is the amount that you charge a client on top of your cost of goods sold. A margin, which is also known as gross margin or gross profit margin, refers to the amount that your company keeps out of total revenue after the cost of goods sold is accounted for. If you look at each as a dollar amount, these two can refer to the same number. However, when you look at them as a percentage, they are quite different.
Let’s take a look at each formula:
- Markup = (Sales – Cost of Goods Sold) / Cost of Goods Sold
- If you have a product that sells for $100 and it costs you $60 to make, your Markup price is $40. But the percentage is 66.7% markup.
- Margin = (Sales – Cost of Goods Sold) / Sales
- If you have a product that sells for $100 and it costs you $60 to make, your margin price is $40. But the percentage is 40% margin.
This is why it is important to remember that there is a difference. As your margin grows, the markup increases at an even greater rate. Since markup is based on the cost of goods sold, it is quite useful for your company to know its costs. If you know the cost of the products or services you are selling, then you can easily figure out the right prices using a simple markup percentage. Plus, this pricing model allows you to arm your sales force with a range of target markup percentages designed with your desired margin built-in. This allows you to generate healthy profit margins.
For more information or if you have questions please talk to your accounting professional! They can help you determine if you have the right profit margins.