We hear these terms Margin and Markup being used, especially in retail store management, but do you really know what they mean? There’s a very important difference between the two when expressed as a percentage that can cost you big money if you don’t know the difference.
First, let’s get some basic definitions out of the way.
Revenue is income. In a retail environment this is most typically from sales of merchandise.
Cost of Goods Sold is your direct cost to acquire (or manufacture) the merchandise being sold. It does not include overhead expenses.
Gross Profit is the difference between Revenue and Cost of Goods Sold.
Margin is also the difference between Revenue and Cost of Goods Sold.
Margin is also another word for Gross Profit.
In retail, the term Margin typical represents the profit calculation of one item while Gross Margin represents the calculation of multiple items.
Margin = Sales – Cost of Goods Sold.
Markup is the amount you add to your cost to arrive at your sales price.
Margin also another word for Gross Profit.
Markup = Sales – Cost of Goods Sold.
So, at this point, there is no difference between Margin and Markup; they both represent profit in dollars. You must be thinking, hold on here, he said at the beginning of this article that there was a very important difference between margin and markup that could be costing me big money if I don’t know the difference, and now he’s telling me there is no difference, I’m confused. We’ll clear that up right now…
The difference between the terms comes in when you are pricing your merchandise and using these terms as pricing calculations expressed as a percentage, such as Margin percentage or Mark-up percentage.
When the terms are used this way, they take on a more expansive meaning because whenever there’s a percentage used, there’s a comparison involved, and that’s where there becomes a big difference.
Margin Percentage is the comparison of Gross Profit to Sales.
Margin Percentage = [(Sales – COGS) / Sales] x 100%
Markup Percentage is the comparison of Gross Profit to Cost of Goods Sold.
[Markup Percentage = [(Sales – COGS) / COGS] x 100%
Example: If you had Sales of $100,000, and your Cost of Goods Sold was $80,000, you’d have a Gross Profit of $20,000 ($100,000 – $80,000).
Gross Margin Percentage is [$20,000 / $100,000] x 100% = 20%
Gross Markup Percentage is [$20,000 / $80,000] x 100% = 25%
So, what does it all mean? In this situation your Markup Percentage was 25%, which means that you marked up your cost of $80,000 by 25% which is $20,000 ($80,000 x 25%) to arrive at your Sales Price of $100,000. This yielded a Gross Margin Percentage of 20%.
You can see that as long as you sell your merchandise at a Gross Profit (not a loss), then the Margin Percentage will always be lower than the Markup Percentage.
Still wondering where the relevance is in all of this? Well, you intuitively know that you have to markup your products so that you make some Gross Profit, but how much?
Every company should have targets for Gross Margin Percentage. Why? Because it’s the Gross Profit that funds all of the general and administrative expenses such as rent, utilities, salaries, and taxes. If your Gross Margin Percentage is too low, there’s not enough Gross Profit generated to support your overhead.
Take-away: Calculating the Gross Margin Percentage you need to break-even and translating that into a Markup Percentage is your first step to breaking even in retail. But, you should add some extra profit because you’re not in business to break-even are you?
You can derive the Markup Percentage from a Margin Percentage using this formula:
Markup Percentage = [ (Margin Percentage) / (1 –Gross Margin Percentage) ] x 100%
Example using Margin Percentage of 20%:
Markup Percentage = [ 20% / (100%-20%) ] x 100%
Markup Percentage = [ 20% / 80% ] x 100%
Markup Percentage = [0.25] x 100%
Markup Percentage = 25%
We can help you determine your break-even Gross Margin Percentage so that you will know exactly how much you need to Markup your products and services. Contact us today from the “Contact Us” link above.