Determining the right price for your products is one of the biggest decisions you’ll have to make as a business.
You need to ensure that the price remains high enough to turn a reasonable profit while also remaining competitive in your marketplace. These two things can be hard to balance.
This is where being able to calculate your markup and margin becomes essential. These two numbers are used to calculate the cost of the goods sold and the sale price. While they have a similar purpose, there are important differences you should understand.
So, what is the difference between markup and margin? And, why do people often confuse markup vs margin?
Let’s answer these questions.
The most important thing to understand when comparing margin vs. markup is that while they have similar purposes, the calculation method has significant differences.
These two calculations approach the same problem from different angles, allowing businesses to better understand how to set up an effective pricing structure and providing more insights about performance.
The difference between margin and markup is not just about the formula or the purpose but also about the information they present.
While margin helps you understand the difference between the sales price and the cost of goods, markup is the amount you choose to charge above the cost of goods. That’s a subtle distinction but an important one, especially when using these formulas to make crucial decisions for your business.
With that in mind, to make sure that the markup vs. margin calculation is as clear as possible, let’s break down the two formulas using an example.
Even though markup versus margin can be challenging to understand, the good news is that the formulas for calculating both are relatively simple. This means that once you know how to use them, actually applying these calculations to your pricing strategy will be easy.
To make the differences easier to understand, let’s look at the difference between markup and margin in a specific example.
Let’s say you’re selling a product for $1,000, and the costs associated with manufacturing and selling it are $800.
If you were to calculate the margin, you would subtract the $800 from the sale price of $1,000, meaning your margin is $200, or 20%.
Meanwhile, if you wanted to calculate the markup, you would divide the margin of $200 by the product cost, which is $800, which would equal 25%.
As you can see, although margin versus markup is often mistaken for one another, they produce different results and are even used in different situations.
Now that we understand how profit margin vs. markup is calculated, we can look into where applying each of them makes the most sense.
In general, markup is used for determining the price of the product. Since it already uses the margin as one of the numbers required for the formula, this makes it more effective at helping you understand how much you need to make on every purchase to remain profitable after all the other expenses have been considered.
It can also help determine the lowest price you’re willing to sell products while also sustaining your business.
Meanwhile, margins are usually used to calculate annual performance, allowing you to see how the various costs associated with product sourcing and selling are related to the sales price you can charge.
Even though the margin vs. markup differences can cause a bit of confusion, it’s clear that both play an essential role when tracking your profitability and setting up sustainable pricing structures.
Therefore, you must provide your staff with the resources they need to fully understand the implications behind both and the best practices of using them.
To start, perform a thorough audit of your current pricing and sales transactions, looking at whether the terms were used correctly. If not, you should calculate the discrepancies that resulted from using the wrong formula and make the necessary adjustments as soon as possible.
If you find that your team has been misusing the formulas, you can provide them with relevant resources or even a cheat sheet with the definitions, purposes, and calculation examples.
A solid understanding of markup vs. margin is an integral part of measuring performance and developing an effective pricing strategy for your business.
Of course, another factor that can have major implications for your business performance is the point of sale (POS) platform you use for your business management needs. Revel’s cloud-based POS software is feature rich and provides the most cutting-edge solutions on the market. Leverage our tools to better understand how your current pricing structure performs while also ensuring customer satisfaction.
To learn more about our POS system hardware, contact us today. Request your free demo to see all that Revel Systems can do for you.