Business owners often confuse margin and mark-up. Each figure helps you set prices and measure productivity. But, a margin vs. mark-up chart shows that the two terms reflect profit differently. It’s important to know the difference between margins and mark-ups in your pricing.
To understand margin vs. mark-up, here is a quick revision of three key terms you need to know:
Revenue is the income you earn by selling your products and services. Revenue is the top line of your income statement and reflects earnings before deductions.
Cost of Goods Sold (COGS) includes the expenses that go into making your products and providing your services. Calculating COGS could include materials and direct labour costs.
Gross profit is the revenue left over after you pay the expenses of making your products and providing your services. Gross profit is revenue minus COGS.
You will use these three terms when finding both margin and mark-up. Understanding the terms will help you grasp the difference between margin and mark-up.
A common confusion in pricing is the difference between mark-up and margin. Here’s a quick explanation of both.
Mark-up is the percentage a cost is increased (“marked up”) to determine a resale. For example, if an item costs $2.00 and the mark-up is 20%, the resale is $2.40 (the original cost plus 20%). The simple calculation is the cost multiplied by the percentage + 1. For example:
$2.00 X 1.20 = $2.40
Margin, short for ‘profit margin’, is the percentage of a resale price that is profit. For example, if an item costs $2.00 and the profit margin is 20%, the resale is $2.50 (the profit of .50 is 20% of the $2.50 resale). The simple calculation is the cost divided by 1 minus the percentage. For example:
$2.00 / (1-.20) = $2.50
Notice the different resales that result from applying mark-up or margin. While mark-up is common in some industries or applications, margin is by far the most commonly used pricing calculation in contract manufacturing.
Knowing the difference between a mark-up and a margin helps you set goals. If you know how much profit you want to make, you can set your prices accordingly using the margin vs. mark-up formulas.
If you don’t know your margins and mark-ups, you might not know how to price a product or service correctly. This could cause you to miss out on revenue. Or, you might be asking too much, and many potential customers are not willing to pay your prices. Check your margins and mark-ups often to be sure you’re getting the most out of your strategic pricing.
Let us know if you would like to discuss how this could impact your business.