Markup vs Margin - Which Should You Use?
It goes without saying that understanding your business’s finances is extremely important. Regardless of whether you sell goods or services, you’ll have to decide how much to charge and what your ideal take-home profit is.
Every company will base its prices on either markup or margin percentage. So, which pricing structure is better for your business? Which guarantees the most profit? How do you calculate markup and margin? We answer these questions below.
Definition and formula
Markup and margin require the same numerators: cost and revenue.
Cost refers to how much it costs you to acquire items or deliver services (for example, how much you paid for the item from a wholesaler).
Revenue, price, or customer price, refers to how much you charge customers to access your items/services.
If you know both the cost and revenue, you can calculate your gross profit, which is the revenue left over once you take away the price of goods - i.e. how much profit you earned from the sale.
The main difference between the margin and markup is that markup shows the difference between how much you paid vs how much the customer pays, and margin shows the difference between how much the customer pays and your gross profit.
Markup
The basic rule of any business model is that you must sell products for more than you buy them for in order to make a profit This is known as markup. Your markup percentage is the difference between how much you paid for something vs how much your customer paid.
To calculate markup percentage:
Look at your selling price (revenue), then subtract how much it cost you to buy it (cost). This tells you your profit.
Then, divide your profit from the cost.
Multiply this figure by 100 to calculate the markup percentage.
(Price - Cost)
÷ Cost
x 100
For example, you’re selling a shirt that you bought for £5, for £35. To work this out, calculate:
35 - 5 = 30
30 ÷ 5 = 6
6 x 100 = 600% markup.
Margin
Your margin is how much of each sale can be determined as profit. It calculates the gap between your selling price and your profit.
To calculate your margin, calculate your profit by removing the cost price of an item from the revenue price you sold it for.
Then, divide your profit by the revenue cost. Multiply by 100 to convert into a percentage.
(Price - Cost)
÷ Price
x 100
Using the example of the shirt again:
(35 - 5) = 30
30 ÷ 35 = 0.85
0.85 x 100 = 85%
To recap: markup looks at how much money something has been increased by in order to create profit. Margin focuses on the customer price minus initial seller cost.
Why they matter
Understanding margin and markup can help ensure that you are pricing your products appropriately. It avoids things being sold for too high a price, which could deter customers, or selling them for too low a price, resulting in the loss of profit. Companies should adjust accordingly, using both markup and margin where relevant. It’s important to decide on the correct pricing structure in order to earn enough profit to be successful, yet remain competitive against other companies in the field [1].
When to use markup
To determine a selling price, you should use markup. Many businesses use a set markup percentage applied to all items. There are some standard accepted margins within industries, however, these are not set in stone and can vary greatly between specific businesses. Generally, retail grocers will have markups of less than 15%, while the average markup in the restaurant industry sits around 60% [2]. This does not reflect gross profit, but the difference between cost price and selling price.
Deciding on a baseline markup percentage will require you to take a few things into consideration: custom pricing for different channels, bulk order discounts, value perception, margin, and customer engagement and loyalty. [3]
Markup alone should not be used to plan price since it doesn’t take other overheads and staffing costs into account. However, when used as a baseline or starting point, markups guarantee that you are always generating at least some profit.
When to use margin
Using your gross margin as a baseline makes it easier to predict profitability.
Some people might assume that low-profit margins indicate low income, but this isn’t always the case.
Referring back to the restaurant industry as an example. The typical markup for produce is cited at 60%. However, the average restaurant net profit margin is 3-9%. Interestingly, the profit margin is higher for fast food and takeout, than it is for full-service restaurants - which demonstrates that more expensive pricing does not equate to higher profits.
Net profit takes other factors into account, such as salaries, packaging, general operating costs. This provides a much fuller picture than markup can, as these other expenses contribute massively to your business’s overall financing.
Simplify the process with POS
The best way to create a solid pricing strategy is to incorporate both margin and markup. Understanding and having an overview of these figures is essential in maximizing profit and reducing unnecessary costs. Choose point of sale (POS) software that provides these formulae, and offers integration with your favourite accounting software.
Epos Now’s software offers:
- Integration with Quickbooks, Xero, and Sage - global leaders in accounting software
- Reports which show your profit, margin, and costs
- Insights to how products sell, allowing you to make better-informed business decisions to reduce cost
- Financial overview categorised by time, or shop location
- Multiple ways for customers to pay: till, handheld, card reader, order and pay
You may also like...
How to Increase Restaurant Revenue Without Raising Prices
How to Calculate Food Cost Percentage
