Markup and margin are two of the most important numbers that a business owner or manager needs to know. They help establish pricing and drive profits.
That's why it's vitally important to know the difference between the two. A single mistake can lead to a loss in revenue or an inability to increase eCommerce sales.
Keep reading to learn more about margin and markup, how to calculate them, and how to convert numbers between the two.
What Is Margin: Margin Definition
Margin, or gross margin, is the difference between the price a product is sold for and the cost of goods sold. Essentially, it's the amount of money that is earned from the sale. Margins are shown in percentage form and establish what percentage of the total revenue can be considered a profit.
For example, let's say you're a food wholesaler who sells whole turkeys for $20 and that only cost you $10 to acquire. Your gross profit would be $10, but your profit margin would be 50%. That is, you keep 50% of the sales price as the other 50% was used in buying the turkey.
How to Calculate Margin
Calculating margin requires only two data points, the cost of the product and the price it's being sold at. To get the most accurate cost for a product, you'll need to factor in all elements of the production or procurement process for that product including raw materials.
You can use this formula to calculate margin:
Margin = ((Sales Price - Cost) / Sales Price) x 100
What Is Markup: Markup Definition
Markup is the amount that you increase the price of a product to determine the selling price. Though this sounds similar to the margin, it actually shows you how much above cost you're selling a product for. Like margins, markups are shown in percentage form.
Let's return to our example above. You've sold a turkey for $20 that cost you $10. The gross profit is $10, which is a 100% markup. This makes sense, as the sales price is double the cost. This also means that you are selling the turkey for 100% more than you paid for it.
How to Calculate Markup
Calculating markup is similar to calculating margin and only requires the sales price of a product and the cost of the product. Certain industries are known for having average markups that few businesses go outside of, so calculating this number can help you compete.
You can use this formula to calculate markup:
Markup = ((Sales Price - Cost) / Cost) x 100
Markup vs Margin
Though commonly mistaken for one another, markup and margin are very different. Margin is a figure that shows how much of a product's revenue you get to keep, while markup shows how much over cost you've sold it for.
In fact, mistaking these two numbers can lead to quite a few problems. Here are a few reasons it's important to know the difference:
Maintain Profit Margins
Since a product's markup is higher than its margin, mistaking the two can be quite costly. If you accidentally markup the price based on margin, you'll be pricing products too low. This will result in lost revenue and your margin will be much lower than planned. This can be very detrimental to your business if you've increased costs like overhead expenses or set inventory KPIs based on flawed pricing. It can also cause you to sell out of a product and end up upsetting customers who want to buy the product that turns into a backorder.
Avoid Demand Loss
Conversely, if you think your goal markup should be the margin, you can accidentally be pricing your products too high. This is very off-putting to customers and can damage your relationships as well as drive down demand for the products. Even worse, this can cause a bullwhip effect that will upset the supply and demand balance throughout your entire supply chain.
Optimize Inventory Management
Calculating the reorder point, determining the proper amount of safety stock to keep on hand, and demand forecasting all depend on understanding your margins and markups. If your numbers are flawed in any way, you can cause a backlog of work for your fulfillment team or end up with piles of dead stock in the warehouse. The cost of this mistake can quickly add up.
Margin vs Markup Chart
Margins and markups actually interact in an entirely predictable manner. This means you can use one to determine the other. This can be done using formulas or a calculator. You can also use a markup vs margin table to easily see this relationship for the most common rates.
To help, use this simple margin vs markup chart:
Margin vs Markup Calculator
Since margin and markup are correlated, each can be converted into the other number fairly easily. Use the formulas below to convert your numbers and get a better understanding of your pricing.
To convert markup to margin, use this markup vs margin formula:
Margin = (Markup / (1 + Markup)) x 100
To convert margin to markup, use this formula:
Markup = (Margin / (1 - Margin)) x 100
Within the Margin of Error
Calculating your margin and markup allows you to make informed decisions to establish pricing and maximize profits. Knowing the difference between markup vs margin is key to avoiding a costly mistake and will ensure you can meet customer demand.
Use the tools above for your calculations and double-check everything before moving forward. You should also check your margins and markups regularly to ensure you're getting the most out of your pricing and online marketplace presence.