Lisa Borga

The terms margin and markup are often confused, but they have different meanings.

Margin, also called profit margin is the revenue a business has in an accounting period after subtracting business costs.

In contrast, the term markup means the amount a business adds to the cost of a product to obtain the selling price.

It is essential to understand this difference to avoid setting a selling price that is too high or low.

Setting a price that is too high or low could cause a business to lose sales or make less profit than they could have.

It could also cause a loss in market share due to having prices that are not competitive with similar businesses.

## Understanding Margin

Margin is the revenue a business has once they have subtracted the cost of goods sold.

Calculating the margin of a business is not difficult.

However, there are a few terms that it’s best to understand before trying to calculate the margin, such as:

• Cost of Goods Sold: These are the direct costs a business incurs in producing any services or products. This would include items, such as direct labor, raw materials, and packaging, among others.
• Revenue: Revenue is the income a business has earned after selling its products or services. Revenue shows the money made from sales without any deductions.
• Gross Profit: The gross profit is the revenue that is left over after the business has subtracted the expenses the business incurred to manufacture and deliver its product.

Here is the formula for calculating the margin.

Margin = (Revenue – Cost) / Revenue

The profit margin of a company is very useful for evaluating its financial performance.

This metric shows whether or not a business is making money on its sales.

It also shows how efficiently the company’s managers use labor and supplies in the production process.

## Markup Explained

Markup is similar to margin in that it measures the profit of a sale.

But, instead of seeing gross profit as a function of revenue, mark-up sees it as a function of the business’s cost of goods sold.

Markup is basically the percentage a business adds to its cost of production when it prices its goods for sale.

Here is the formula for markup.

Markup = (Revenue – Cost of Goods Sold) / Cost of Goods Sold

Markup is important. The higher the markup, the greater the revenue the company will make per item.

However, a higher markup could reduce sales.

If a company wants to set a price for a product based on markup, they need to determine all of the costs involved with producing and selling the product.

Then, the company can multiply the product cost by the desired markup to obtain the price.

## A Comparison of Margin and Markup

It is easy to see how these two concepts could be confused with each other.

They are looking at the same transaction and using the same data.

But, they do provide different information.

Here are some of the differences between margin and markup.

• Margin measures how profitable a business is. It shows what percentage of a company’s sales is profit. In contrast, markup is the amount added to the cost of producing a good when setting its price.
• The margin can be calculated by dividing the gross profit of a business by its revenue. To find the markup, the cost of goods sold is subtracted from the revenue, and this figure is divided by the revenue.
• The margin helps businesses to see if they are making a profit on their sales. Whereas a markup helps businesses to make sure that they are making a profit on each sale.
• The calculation for margin is based on revenue. Whereas the calculation for markup is based on the cost of goods sold.
• The margin takes the perspective of the seller. In contrast, the markup takes the view of the buyer.

## Margin Example

Suppose a business sold a pair of boots for \$100 that cost \$60 to make.

Here is how to calculate the margin.

Margin = (Revenue – Cost) / Revenue

Margin = (\$100 – \$60) / \$100 = .4 margin

The margin could also be stated as a percentage as follows.

.4 x 100 = 40% margin

A higher margin indicates the company is keeping more of the money from a sale.

## Markup Example

The same example can be used to calculate markup.

It costs a company \$100 to produce a pair of boots, and they sell the boots for \$60. Here is how to calculate the markup.

Markup = (Revenue – Cost of Goods Sold) / Cost of Goods Sold

Markup = (\$100 – \$60) / \$60 = .67

Markup can also be stated as a percentage, as shown below.

.67 x 100 = 67%

As with margin, a higher markup will ensure the company keeps a larger part of the revenue after the sale.

The formulas for margin and markup can be used to see how margin and markup interact with each other.

A certain markup will always result in a certain margin.

Here is a chart with some examples of which markup produces which margin.

 Markup Margin 20% 16.7% 30% 23% 40% 28.6% 50% 33%

As can be seen from the above chart, in order to obtain a certain margin, the markup for the product needs to be higher than the desired margin.

This is necessary due to the fact that the markup calculation is based on cost, not revenue.

So, to ensure the cost is lower than the revenue, the markup percentage needs to be higher than the margin percentage.

## Final Thoughts

It is essential to understand the difference between margin and markup.

If these terms are confused with each other, your business could end up losing money.

But, if the terms are properly understood, it could help not only in setting prices but in planning and implementing strategies for your business.

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1. Penn State "What's the Difference Between Markup and Profit?" Page 1 . August 12, 2022

2. Harvard Business School "2 WAYS TO INCREASE PROFIT MARGIN USING VALUE-BASED PRICING" Page 1 . August 12, 2022