What Is the Difference Between Margin and Markup?
Margin (or gross margin) and markup are two different ways of expressing the difference between the cost of a product and its sale price. However, margin and markup are computed differently and are used for different purposes, depending on which is more suitable. Most small businesses use markup formulas, but many neglect margin. That's a mistake, according to business consultants, since using margin as a tool for analysis helps improve profitability. It's well worth the time for any businessperson to know the difference between margin and markup and use both.
Identification
Markup is the amount (usually expressed as a percentage) that is added to the cost of a good to set the selling price. For example, if an item costs $10 and the markup percentage is 50 percent, you add $10 (50 percent) or $5 to get a price of $15. The margin of a good that has a $15 price and a cost of $10 is the price minus the cost (in this example, $5). Express this as margin percentage by dividing the margin by the price and then multiplying by 100. Our $5 margin divided by the $15 price (times 100) yields a margin percentage of 33 percent.
Significance
Margin and markup have different uses. Generally, a markup formula is used to set the price of a product. It's a simple and easy way to guide sales personnel and managers. Margin is more useful for analyzing sales and expenses. Typically, you use data from a given period (such as the previous calendar quarter) to determine how much margin is required for existing sales volume to cover added expenses plus an adequate profit. The goal is to use margin analysis to adjust prices and determine what your markup formula should be.
Features
The cost of a product is a common factor for both margin and markup. It consists of the purchase price of the item (raw materials) plus labor and may include items like breakage allowance. Cost does not include other expenditures such as rent, administrative salaries and office expenses. A margin analysis takes actual data on costs, sales and expenses and creates a model that allocates the proportion of expenses that the margin must cover. Once you do this analysis, you have the necessary information to effectively set or adjust prices and create a useful markup formula for pricing.
Function
It is frequently necessary to convert margin to markup to establish a markup formula. To do this, subtract cost from the sale price to obtain the margin. Then divide margin by cost (multiply by 100 to get the markup percentage). For example, an item with a cost of $10 and a price of $15 has a margin of $15 minus $10, or $5. Divide $5 by cost ($10) and multiply by 100 to get the markup percentage of 50 percent. You don't really need to convert markup to margin; just subtract cost from the price to get the margin. Divide by the sale price and multiply by 100 to find the margin percentage.
Considerations
Determining the right markup to set the price of a product is vital. You don't want to underprice or overprice products. Tracking margin on a regular basis enables you to avoid both problems. Using margin to analyze sales and expenses can also help you to identify products that are not "pulling their weight." Another advantage is identifying how much you can offer in coupons and sales to build customer base and sales volume without discounting too deeply.
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