Many people starting a business run into trouble when they fail to understand the difference between markup and margin.
Most people will price their jobs based on markup rather than margin. Yet it is the margin that represents the profit in the job, hence it is the margin that is of most interest to us.
To make sure you make the profit you should be making, it is important to understand how both of these work (and how to calculate them).
So what’s the difference?
How to Calculate Markup
Markup is the difference between the sale price and the cost of the product or service divided by the cost. (expressed as a percentage)
So let’s look at a simple example:
If an item costs $10 and you sell it for $13 the markup is:
Markup = [(Sale Price – Cost) /Cost] x 100 %
= [(13 – 10) / 100] x 100 %
How to Calculate Margin
Margin is the difference between the sale price and the cost of the product or service divided by the sale price. (expressed as a percentage)
For the same item described above the margin would be:
Margin = [(Sale Price – Cost) / Sale Price] x100 %
= [(13 – 10) / 13] x 100%
= (3 / 13) x 100%
So how do they become confused? 😕
In the example above we have marked up the job by 30% and then later decide to discount our price to win the job. We think we could drop our price by 25% and still make a small profit…. right?
In the first instance, even though a 30% markup has been applied, the 25% discount is applied to the margin.
Let’s do the sums to see what happens:
Cost Of Item: $10
Original Price: $13
Original Price: $13
Discounted Price: $9.75
Loss : $0.25
This number may be small but if this was a $1000 job you would have just lost $250!
The lesson here is to understand the difference between markup and margin. And be sure to know your margins on each job. If you get this wrong, you are going to run out of money very quickly.
Finally, when you are pricing jobs, make sure that your markup allows for all the costs in your business:
- Material costs;
- Cost of sales;
- General overheads.
That way you can price in a way that will ensure you end up with profit at the end of the day.