Table of Contents
- What is it and how is it calculated?
- Markup formula
- What is the difference between margin and markup?
- Who uses margin and who favors markup?
- Easy guide to calculating the markup (step by step)
- Frequently Asked Questions
- What is a good markup percentage?
- Is markup a good tool for comparing the profitability of companies?
- How do I know whether a company is profitable?
- Are there some specific products that have unusually high markups?
If you are a business owner, you probably already know that the most significant factor determining the success of your company heavily depends on you turning a profit. Setting fair prices that will prompt customers to purchase your goods or use your services is as fundamental as making sure you don’t incur any losses in the meantime.
It is certainly not an easy task. Don’t worry, though — Calcopolis is coming to your rescue! Popular among the world’s most respected business people, this tool can help you not only calculate your ideal markup prices but also ensure that you always remain in the black.
What is it and how is it calculated?
In business, markup is defined as the ratio between the final selling price and its cost. Usually expressed as a percentage increase on top of the cost, a markup rate appears in every transaction.
When calculating the markup, you need to know the total amount of fixed and variable expenses covering both the production and the distribution of your product.
In retail, for example, businesses calculate the markup as the difference in percentage between the retail price and the wholesale price. However, it is necessary to remember that the markup is not indicative of the actual profit made by a company. Oftentimes even businesses with high markups are not able to cover all their expenditures, such as taxes or debts. Therefore, it is crucial to use the right formulas created specifically for the type of company that you run.
1. If you wish to calculate the percentage markup:
markup = (profit / cost) * 100%
You need to multiply it by 100% if you want to express it as a percentage and not as a fraction.
2. If you wish to calculate the selling price:
price = unit cost x (1 + markup / 100%)
If you price your goods according to this formula, you need to double check if your markup covers all the costs related to the transaction. By doing so you can be sure you will be generating profits.
Unfortunately, it doesn’t always work like that. The selling price cannot be too high. Luckily, there are different strategies that may be even more advantageous, such as linking the markup to the price elasticity of demand.
cost = profit / (markup / 100%)
Since markup is a percentage value - you need to divide your markup by 100% before you divide it by profit!
What is the difference between margin and markup?
Is it a gross margin or is it a markup? You’ve probably asked yourself that question numerous times. To solve this problem once and for all let’s look at the definitions of these two concepts listed below.
Markup is the difference between the cost of a product or service and its sale price. As a general rule, markup must be set in such a way to allow your company to make a reasonable profit. The markup price can be calculated both in your local currency and as a percentage.
Gross margin, however, is known as a ratio of profit to revenue as opposed to markup’s ratio of profit to cost. In effect, gross margin allows you to compare your company’s profit to the sale price and not to the purchase price.
Markup and margin are two distinct accounting terms. Even though they analyze the same transaction, they are doing it differently. That’s precisely why they provide different pieces of information.
Let’s clarify it with an example. Assuming that you have a product that sells for $10 (revenue) and that costs you $4 to make, your gross profit on this product amounts to exactly $6, meaning that the gross margin is 60%.
The markup percentage, on the other hand, will be calculated by dividing the selling price ($10) by the manufacturing cost ($4), which gives you 250% markup.
Of course in both cases your profitability stays the same, it is simply expressed using different indicators.
Who uses margin and who favors markup?
Both concepts help calculate a profitable selling price and can be employed interchangeably. Nevertheless, you can actually observe some preferences that certain types of businesses have. Gross margin is most commonly used in retail, and in effect is widely quoted by such companies across the globe.
It is especially helpful when indicating the profitability potential of large sectors or markets. A low margin often translates to very intense competition on the market.
Margins also come into play quite frequently when a business seeks additional funding. A local retail store, for example, may need to provide it to the bank before being able to apply for a loan.
The markup on the other hand is usually used by wholesalers, service providers, and manufacturers. Establishing a markup is especially important for entrepreneurs just starting a business. Many companies calculate their selling prices employing this strategy, as it very clearly shows whether a firm is making a profit or incurring some losses.
Easy guide to calculating the markup (step by step)
Determine your COGS (cost of goods sold), e.g. $100.
Find out your gross profit by subtracting the cost from the revenue. Assuming that your product sells for $150, the profit equals $50.
Now divide your profit by the cost of goods sold. In this case, $50 divided by $100 amounts to 0.5.
Multiply 0.5 by 100% to convert the result to the percentage.
In this case your markup will be 50%.
And that’s precisely how you find your markup. Now, let’s try it out on some more complicated examples.
Example A. We are calculating the retail markup percentage for a clothes shop. A T-shirt costs us $5 to produce but we are selling it at a price of $19,99. It’s also worth noting that we have to remember to subtract the 20% sales tax from the original selling price.
Cost of the T-shirt = $5
Price_with_taxes = $19,99
Price_after_taxes = $16,66
markup = (price_after_taxes - cost) / cost
markup% = markup x 100%
markup = ($16,66 - $5) ÷ $5
markup = $11,66 ÷ $5
markup = 2,332
markup % = 2,332 x 100%
markup % = 233,2%
Therefore, in this case, the markup equals 233,2%. Keep this in mind when you go shopping next time :)
Example B. We are calculating the markup on services. A system admin makes $40 per hour but the company leases his work for approximately $60 per hour. We are not including taxes in this example.
markup = (price estimated by the company - admin's hourly rate) / admin's hourly rate
markup % = markup x 100%
markup = ($60 - $40) / $40
markup = $20 / $40
markup = 0.5
markup % = 0.5 x 100%
markup % = 50%
In this example, the markup percentage amounts to 50%.
Frequently Asked Questions
What is a good markup percentage?
There is no such thing as a “good” sales markup. It depends on the structure of your company and the full amount of costs that you are incurring. The most fundamental question to ask yourself while setting a price markup should be “Will I be able to cover all the expenses and still make some profit?”
Is markup a good tool for comparing the profitability of companies?
Simply answered, no. Cost and markup are not a good tool for comparing the profitability of companies. Every business has a different structure of costs. It would be highly unfair to compare companies from different industries by a markup percentage. But it does bring us some kind of valuable information. Nonetheless, it is pivotal to use multiple tools while determining which business is more profitable, and not just opt for one of them.
How do I know whether a company is profitable?
Although markup can tell you if a particular company is profitable, you will need to dive deep into the cost structure of that particular company in order to be able to evaluate its profitability.
Are there some specific products that have unusually high markups?
Actually, yes, there are! Surprisingly the cheapest products may have the highest markups. If something costs a few cents, customers usually don’t pay much attention to the price and sellers rip the benefits of it.
Local monopolies try to set prices as high as possible. That's why snacks in the cinema are so expensive. The markups on candies in the movie theaters could easily exceed 1000%.
An even higher percentage can be found in bottled water (4000%) since a small bottle of water can cost more than a cubic meter of tap water.