Simply put, margin is revenues minus the cost of goods sold, while markup is the amount by which the cost of a product is increased in order to derive the selling price.
While they are related, they refer to different things.
Yes, both rely upon the same basic numbers and both analyze the same transactions. However, the information derived from the calculation of each is different. Ironically though, the terms are increasingly being used interchangeably.
This is a dangerous mistake— one that could lead to significant accounting errors. So let’s take a moment to better understand margins vs. markups.
What is a Margin?
Let’s say you have an item that sells for $100 and it cost you $70 to get it. The difference between what it cost and what you sell it for is your margin, which in this case is $30—or 30 percent. Dividing the margin by the sale price will derive that figure for you.
However, this is but one form of the concept—and for a single product.
The following must also be calculated for the business as a whole to get a clear picture.
- Gross Margin: Revenues minus both the fixed and variable components of the cost of goods sold.
- Contribution Margin: Revenues minus all variable expenses.
- Operating Margin: Revenues minus the cost of goods sold and all operating expenses.
- Profit Margin: Revenues minus all expenses, including financing and non-recurring expenses.
Therefore, when one is discussing margin, it’s important to specify which form of the concept you’re considering in order to get an accurate accounting of the parameter with which you’re concerned.
What’s a Markup?
Meanwhile, markup is expressed as the percentage by which your cost is increased to reach your selling price. Using the example above, in which our cost is $70 and our selling price $100, we have a markup of 42.9 percent. Dividing the markup amount of $30 by the product’s cost of $70 gives us the markup percentage.
But guess what?
Determining the proper markup isn’t really that simple.
Mitigating Circumstances Matter
Factors other than cost will have an effect on your selling price, and in turn, your markup. As a result, using a simple formula such as the one above to establish the price of an item isn’t always feasible.
Sure, it’d be great to decide you’ll have a markup percentage of 42.9 percent for all of your products across the board. This would make calculating your margin simple too—regardless of the operating parameter with which you’re concerned.
However, you must also take the marketplace into consideration.
What are shoppers willing to pay for the item? What if the item is seasonal?
If you sell electronics using a platform like Shopify, you’re likely to find big screen TV sales are stronger during the weeks leading up to the Super Bowl.
Consequently, you might be able to get away with slightly higher prices during that period.
Conversely, people buy fewer sets during the vacation season, so you might have to discount their prices more to keep them moving. In essence, you’ll have to find the price that gives you the opportunity to maximize your profit, while remaining competitive—during varying market conditions.
The Bottom Line
Basically, understanding margins vs. markups requires looking at opposite sides of a transaction.
Margin speaks to your profit as derived from the selling price, while markup looks at the profit as it relates to the cost of the product. Margin usually takes all of your costs into consideration, while markup is only concerned about a specific item in relation to its costs. However, both must be considered to develop a pricing strategy capable of ensuring profitability.