Markups and margins: know the difference!
Knowing the difference between markups and margin calculations is essential for your business and ultimately, your bottom line.
When it comes to understanding the difference between markups and margins, the first thing you need to know is this: markup is based on cost, while margin is based on revenue:
Markup is the amount added to third party costs, to arrive at the total amount charged on to your client.
Margin is the difference between the cost and the sale.
So what should your policy be? Should you quote markup? Or margin?
"The classic tip here is: If you don't ask, you don't get. Applying a markup or achieving a margin is about being fair and equitable."
Getting these wrong can be devastating for your business because there is a huge difference between (for instance), 50% markup compared to a 50% margin. Let’s look at that difference:
Calculating the sell price using margin
To illustrate the difference between these two tricky calculations: let’s say that you have an external cost of $1,000 and your policy is to achieve a 50% gross margin.
Your calculation will be: Divide the $1,000 cost by 0.5 = $2,000 sell price.
Calculating the sell price using markup
If, however, your business has a markup policy of 50% on external costs, then you would sell the $1,000 item for $1,500 instead of the $2,000 calculated above.
Your calculation will be: $1,000 x 1.5 = $1,500 sell price.
Let’s put these calculations into a real life example:
We’ve accepted a quotation from our print supplier for $10,000. Now we need to ascertain the sell price to our client, either by adding a markup to the supplier cost, or calculating our margin expectation.
If we apply a 30% markup:
Your calculation will be: $10,000 x 1.3 = $13,000.00 sell price.
The gross profit we would earn is $3,000 ($13,000 sell price, less the $10,000 supplier cost)
If we seek to make a 30% margin:
Your calculation will be:
$10,000 ÷ (1 – 0.3)
$10,000 ÷ 0.7 = $14,285.71 sell price.
The gross profit we would earn is $4,285.71 ($14,285.71 sell price, less the $10,000 supplier cost)
Applying the margin policy would mean that we earn $1,285.71 more than if we implemented a markup policy.
So which should you use? Markups or margins?
Markups and margins are often based on industry norms, what the market will bear, and also take into consideration if you add extra value to the product or service.
It is reasonable to implement different levels of markup or margin for different products or services, for example:
- A 10% markup for basic services such as administration supplies (photocopying, stationery etc.).
- 20% markup if the job is slightly more involved.
- 30% markup where your IP, expertise and technical skills are required.
Common things you’d add margin to are items you are purchasing from a wholesaler and then on-selling.
Ultimately however, the aim of applying a markup or making a margin is to ensure you’re charging your client/customer enough to cover any supplier costs PLUS:
- Your time
- Your administration costs
- Your intellectual property (IP)
- Your knowledge of the product or service
- Your technical expertise and know-how
- Time pressure and urgency
So, there’s no need to be shy; just pick one method and be confident as to how much you are charging and why.
Double-check your business terms and conditions contracts and agreements to ensure that you have formally communicated your policy to your client, and that the markup or margin policy you choose ensures that you are able to run a profitable business.
Do you have any further questions about markups vs margins? Feel free to ask them below.