Mark Up vs. Margin – The Difference Can Cost You

Your gross profit margin is one of the most critical key performance indicators for overall net profit – yet it’s misunderstood by many small business owners.

Your gross profit represents what you have left over from sales (income) after you take out the cost of goods or services … and it applies to all businesses.

If you sell products, like retailers or distributors, your costs include inventory.

If you make products, like manufacturers, your costs include raw materials and labor associated with production.

If you sell services, your costs include the labor associated with service delivery and may also include supplies required to do this.

Do you know your gross profit margin and how it compares to your industry? If not, take a few minutes to calculate it – divide your gross profit dollars by the sales / income for the same period. Please note that some small businesses include the above costs with expenses (versus cost of goods sold). Talk to your accountant to make sure your costs are set up appropriately.

Are you surprised? Many small business owners are. And here’s the most common reason … they use mark-up to calculate the selling price and assume the markup percentage is their gross profit margin. Ouch… they are not the same.

In fact, if you mark up your products or services 30% — your gross profit margin on this product or service is actually 23.1%. Below is an example to demonstrate the difference.

Your cost for your product or service is $100
You mark it up 30% — so your mark-up (or gross profit $) is $30
Your selling price (cost + markup) is $130
Your gross profit is $30 – note the mark-up and gross profit dollars are the same
But… your gross profit margin (GP $ / selling price) is 23.1%

I have never been an advocate of using mark-up exclusively to establish selling price because it ignores key pricing elements like value and competition. But if you do use this method, be aware of the difference and start backwards. Decide on your desired profit margin then using the cost, calculate the selling price that delivers it.

Here’s the formula: Cost / 1 – desired GP (decimal). For example, if you want a GP% of 25% – bottom formula would be 1 – .25 = .75. It’s the reciprocal in math terms.

MarkUp-Margin Calculation Tool. For a simple tool to help with margin and mark-up calculations, visit my website to download it now.

Find this helpful? Then share it with others. For additional ideas to grow your small business, visit small business resources on my website. While you are there, join my mailing list to receive my monthly eNewsletter and a free copy of my eBook, Mastering the 7 Elements of Business Success.