see also
Gross Profit Margin Analysis
Operating Profit Margin Analysis
Net Profit Margin Analysis
Retail Markup
Retail Markup Percentage
Contribution Margins
Segmenting Customers for Profit
Markup vs Margin Differences
Is there a difference? Absolutely. More and more in today’s environment, these two terms are being used interchangeably to mean gross margin, but that misunderstanding may be the menace of the bottom line. Markup and profit are not the same! Also, the accounting for margin and mark-up are different! A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking,
markup percentage is the percentage difference between the actual cost and the selling price, while
gross margin percentage is the percentage difference between the selling price and the profit.
So, who rules when seeking effective ways to optimize profitability?. Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement. However, a 25% markup rate produces a gross margin percentage of only 20%.
How to calculate markup percentage
By definition, the markup percentage calculation is cost X markup percentage, and then add that to the original unit cost to arrive at the sales price.
For example, if a product costs $100, the selling price with a 25% markup would be $125:
Gross Profit Margin = Sales Price - Unit Cost = $125 - $100 = $25.
Markup Percentage = Gross Profit Margin/Unit Cost = $25/$100 = 25%.
Sales Price = Cost X Markup Percentage + Cost = $100 X 25% + $100 = $125.
How to calculate gross margin percentage
Gross margin defined is Gross Profit/Sales Price. In this example, the gross margin is $25. This results in a 20% gross margin percentage:
Gross Margin Percentage = Gross Profit/Sales Price = $25/$125 = 20%.
Not quite the “margin percentage” we were looking for.
So, how do we determine the selling price given a desired gross margin? It’s all in the inverse…of the gross margin formula, that is. By simply dividing the cost of the product or service by the inverse of the gross margin equation, you will arrive at the selling price needed to achieve the desired gross margin percentage.
For example, if a 25% gross margin percentage is desired, the selling price would be $133.33 and the markup rate would be 33.3%:
Sales Price = Unit Cost/(1 - Gross Margin Percentage) = $100/(1 - .25) = $133.33
Markup Percentage = (Sales Price - Unit Cost)/Unit Cost
= ($133.33 - $100)/$100
= 33.3%
Markup vs Gross Margin; Which is Preferable?
Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction.
Mathematically markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.
Steps to minimize Markup vs Margin mistakes
Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage.Below are steps you can take to avoid confusion when working with markup rates vs margin rates:
- use a pricing model or pricing tool to quote sales. Have the tool calculate both the markup percentage and the gross margin percentage
- relate gross margin percentage per sales invoice to income statement
- organize your
chart of accounts to compare gross margin rate to sales quotes
- educate your sales force on the differences. By targeting the gross margin percentage vs the markup percentage you can throw an additional 2 - 3 percent profit to the bottom line!
Margin vs Markup Chart
15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit