The language of business is one of numbers, and it is a language that every business owner should understand. When you know the numbers in your business, you can make smart, calculated decisions to move things in the right direction. A critical distinction that we find many business owners are confused about in our business consulting sessions, especially when they are considering discounting their products (which we do NOT recommend), is the difference between margin and markup.
Getting these two terms mixed up – or thinking they are the same thing – can result in some pretty big losses. Here I will explain exactly what each of these terms mean, and how many business owners mistakenly use them.
How to Calculate Markup
Imagine you manage a product-based business and, for simplicity, we are talking about setting the price of the products. If the cost of the goods from the supplier is £100, and I want a markup (not a margin!) of 60%, what is the price I will be selling it at? The answer is £160. Markup is applied to the costs of goods. The equation for how to calculate your markedup price is as follows: Marked Up Price = Cost of Goods * (1 + Markup%) So for the above example: Marked Up Price = £100 * (1 + 60%) = £160
How to Calculate Margin
Now let us imagine that in order to make a good profit, you want a 60% margin on the products you are selling. If that’s the case, what should the price be? The equation for calculating gross margin is: Gross Margin% = (Sales – Cost of Goods) / Sales In this equation, “Sales” refers to the amount of money the item brings in – so this is the price of the item (what we are looking for). While “Cost of Goods” is the costs required to produce the item – so our £100 from above. Re-arranging that equation you end up with: Sales (i.e. Price) = Cost of Goods / (1 – Gross Margin%) Which means: Price = 100 / (1 – 60%) = £250 As you can see, a 60% margin yields a very different price point compared to a 60% markup.
How Markup and Margin Usually Get Confused
Once business owners have gotten their avatar identified, their inbound marketing pulling in leads and their sales team asking all the right questions – it comes time to consider what margins are required for the business and how to increase those margins.
The main problem we find with business owners is that they think, “Ok, I need to achieve a 60% margin. So let me markup my prices by 60%.” However, you can see above that this does not achieve what you need to achieve. In fact, in this example, if you marked up the price by 60%, the price is only £160. That means that the Gross Profit = 100-60 = £60. That then means that the Gross Margin = 60/160 = 0.375 – which is a margin of 37.5% not the 60% that you need to make a good profit.
You can imagine the kind of impact this would have on the business if you were meant to be achieving a 60% margin and were only achieving 37.5%! This is just one example of the kind of numbers that business owners need to understand – and one that could make a very big difference. Learning this language of numbers is not nearly as complicated as most business owners think: when it is explained clearly, it can become very simple and yet result in massive impact for you and your business.
If you regularly mark up your prices, I’d love to hear your experience on how you decide the percentage to use. Do put in your comments below or drop me an email.
If you would like to discuss any of the points covered here, please feel free to request a free call below.