How do you calculate margin vs. markup — and what’s the difference between the two?
It starts with figuring out your product’s cost. From there, you can decide how to price it. Figuring out your product’s cost will depend on several factors, for example, whether or not you buy in bulk, whether you source your products from different vendors for different prices, and so on. Once you have a system to calculate your cost of goods sold (COGS), you can use your cost to calculate your price.
This is where the concept of markup comes in. Depending on where you search, you can get different answers for what markup is and what it has to do with something called margin (or gross profit margin).
Let’s start with a quick overview:
- Markup is the amount by which the cost of a product is increased in order to obtain the selling price. For example, a markup of $90 on a product that costs $110 would give a selling price of $200. Which is an 82% markup (markup divided by product cost)
- Margin is the selling price of a product minus the cost of goods. Using the above example, the margin for a product sold for $200 with a cost of $110 would be $90. Which is a 45% margin (margin divided by the selling price).
If you’re wondering how to untangle that web of M-words, you’ve come to the right place.
Let’s get into it!
Calculate margin vs. markup in video
If you’re one of the millions of people who prefer to learn through the magic of video, we’ve got you covered!
If you’d like a step-by-step breakdown of the formulas, read on!
Calculating the cost of your products
If you’re already confident you know your product’s cost, you can skip this section and head right to the formula; if not, read on!
To get an accurate margin or markup, it’s integral that you know exactly what your product costs. The cost of any product is more than just what you pay for it. As mentioned above, several factors will add to the cost of a product. Some of these factors include:
- Overhead – Expenses such as rent, utilities, taxes, and insurance are all considered overhead costs and should be taken into account when calculating costs.
- Marketing and advertising – Promotional materials and ad campaigns aren’t free and should be rolled into the cost of the product they are promoting.
- Packaging – It may seem small, but even the packaging materials you use and the labor involved in packaging the products shouldn’t be ignored.
- Labor – This one is pretty obvious, but any wages, benefits, or any other expenses associated with the product in question need to be factored into your product’s cost.
Now that we have a more accurate understanding of what our product’s cost is we can use it in our margin and markup formulas.
What is the markup formula?
You can think of markup as the extra percentage you charge your customers (on top of your cost).
The markup formula looks like this:
An example of using the markup formula
Now let’s make the example a little more concrete. Let’s say the cost for one of Archon Optical’s products, Zealot sunglasses, is $18. That $18 is how much it costs Archon Optical to create a single pair of the Zealot. They will then turn around and sell each Zealot for $36.
If we run through that calculation, we arrive at a markup of 100%:
Pricing products based on markup
However, some businesses might set their prices based on a specific pre-defined markup percentage. They’d have the costs ready and have particular markup percentages in mind to help them calculate a price.
How would we express the markup formula in this case? Let’s write this out:
Expressing markup as a percentage can be very useful. This way, you can guarantee that you generate a proportional revenue for each item you sell. Even if, down the road, your cost changes or increases. This means the markups you set up at the beginning should scale well as your business grows. We’ll discuss this more when you’ve scrolled further down this page.
What about margin vs. markup?
Now that we’ve defined markup and how it helps you decide on a price, we should discuss the other big M-Word: margin. The type of margin we’re talking about in this case is gross profit margin, which describes the profit that you earn on a product as a percentage of the selling price.
What is the margin formula?
You would often write margin as a specific amount in currency or as a percentage. However, when calculating margin, you always divide by the price.
If we want to calculate margin for the Zealot sunglasses, here is what that looks like:
The gross profit margin on Zealot sunglasses is $18 ($36 price – $18 cost), or you could say the margin is 50%.
Expressed in this way, you can see that margin and markup are two different perspectives on the relationship between price and cost. Just like you could say a glass is half full or half empty, the difference is all about perspective.
When should I use margin vs. markup?
The question arises: if these two M words are so similar, how do we know which one to express or use at a given time? Here’s our take on that:
Markup is a perfect way to ensure you generate revenue on each sale. Markup is good for getting started because, as you are getting things set up, you are keenly aware of the costs for your business, and you’re still learning about the kind of revenue you can bring in through sales.
As you get to know your business better and you start to look at reports on your sales, margin can help examine how much actual profit you’re making on each sale.
For more of an explanation, check out this Margin vs. Markup video below:
Fixed markup as a percentage or dollar amount
The cost of manufacturing the Zealot may not always stay at $18 (actually, it definitely won’t). So the wise staff at Archon Optical will want to make sure that they constantly adjust prices to reflect the increase in cost.
This is where the concept of fixed markup comes in handy because it can help you automatically adjust your prices based on changes in cost. You could have cost and price as separate numbers that you input into your spreadsheet or inventory management software, but it’s much easier to have them linked in the long run.
Defining your markup as a percentage above cost ensures that you continue earning sales revenue as costs increase. Still, it also means you don’t have to keep going back to adjust your pricing. Manually adjusting your prices based on cost is plausible for a smaller business, but this quickly becomes untenable as your inventory expands to include hundreds of items.
If the Zealot becomes more expensive to produce over time, the price will have to go up, and gaining a markup of $18 on a $36 item is significantly different from a markup of $18 on an item priced at $55. A fixed markup percentage would ensure that the earnings are always proportional to the price.
What other factors affect markup?
We’ve described markup very simply because we’re assuming a scenario where Archon Optical makes the Zealot for a set cost and sells it at a fixed price, and that’s all there is to it. Of course, real life is a little more complicated than that.
As mentioned in the above section about cost, everything involved with the production and distribution of the Zealot needs to be considered.
If you ship Zealot to customers in boxes or send them in trucks to stores around the city, you need to factor in the cost of freight charges. Depending on the shipping carrier you use, the shipping speed, and whether you add insurance can make those costs vary wildly.
Since the Zealot is a product that Archon Optical had to develop over time (it didn’t just materialize as a completed product), they need to account for all of the time that went into making the Zealot aesthetically pleasing while still blocking as many of the sun’s harsh rays as possible. So product development time can also factor into the cost.
Automate your pricing with fixed markup and inFlow
If your costs change often then you probably spend a lot of time making price adjustments. Our inventory software can help you change prices—and your markup—with just a few clicks.
You can set fixed prices for your products, but a fixed markup will always keep your price a consistent percentage above your cost. If you have to update prices on multiple products weekly, this simple feature could save you hours. And you’ll rest easier knowing that your business is making money on each sale, even as your costs change.
But that’s not all—inFlow can help you with many other crucial tasks like setting reorder points and integrating your shipping. You can even set up a complete barcoding system! To learn more about barcodes and how to set up a barcode system, read our Ultimate Barcoding Guide.