The profit of all trade enterprises is based on a simple formula: buy cheaper — sell more expensive. To form the price of goods and services, the concepts of margin vs markup are used, which many consider being synonymous. Nevertheless, they are different: the markup is used in the context of the purchase price, while the margin is used to determine the selling price and serves as an indicator of performance.
Margin or marginality
The margin shows how much of the revenue is profit. The higher the margin, the higher the gross profit. In business, both margin and marginality can be calculated: margin is calculated in money, and marginality is calculated as a percentage. It is better to use rates: they are easier to perceive, and it is more convenient to track dynamics and build graphs with them.
If you have a small business without rent, employees, and division of costs into fixed and variable, then to calculate the margin in currency, you need to subtract its cost from the price of the product:
Margin = Price – Cost
Imagine, you sell bed linen. For a set, including shipping, pay the supplier $180, and sell the set to the buyer for $300. So the margin is $120.
To calculate the margin as a percentage, you must subtract the cost from the product’s price. Divide the outcome by the price of the product and multiply by 100%:
Margin = ((Price – Cost) : Price) × 100%
What is markup?
Markup shows how much marginal income each dollar invested in buying goods brought. A business needs a markup to cover costs and earn a profit. The markup is the amount you add to the product’s sales price or its cost. The markup can be calculated in currency and percentage. For analysis and planning, it is more convenient to use percentages.
If your business operates on a buy-sell basis, then use the formula to calculate the markup percentage:
Markup = ((Sales Price – Purchase Price) : Purchase Price) × 10
Imagine, you sell gloves. You bought a batch of goods from a supplier for $5,000 and planned to sell it for $12,000. The markup is 140%.
Glove Lot Margin = (($12,000 – $5,000) : $5,000) × 100% = 140%
If you have production and a lot of different costs, then it is better to calculate the margin, starting from the marginal income and variable costs:
Markup = (Marginal Return : Variable Costs) × 100%
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The difference between the indicators
The following points are important for the difference margin vs markup:
- A financial metric that measures a company’s profitability, that is, the proportion of revenue left in the business after paying production costs from revenue, is called margin. The value added by the seller to the cost price to cover contingencies and profits to get the selling price is called markup.
- Margin is a percentage of the sale price, and markup is a cost multiplier.
- The margin can be calculated by taking the sale price as a basis. On the other hand, the cost price is considered as the basis for calculating the markup.
The markup is an analytical indicator that is subtracted by comparing the Value Added to the Cost. The markup indicator as a percentage is necessary for managers to understand the price level, profitability, payback, and other parameters of the product being sold. The markup can be 0 more or less, but the higher, the better. There is usually a margin of 20-30% in practice, but this is not to say that the selling price is profitable or pays off. More profound and more complex analytical calculations are carried out to calculate the profitability of the products sold.
Margin is a fantastic indicator calculated by comparing Added Value to Selling Price. The margin is expressed as a percentage and indicates the share of the margin in the structure of the selling price of the goods. Margin is also widely used in managerial decision-making, and according to some theories, it is also an alternative indicator like markups.
In general, both margin vs markup can significantly tell about the activity of the enterprise:
- Calculations of these indicators must be carried out in the prescribed periods and compared with the previous ones.
- Seeing the dynamics of indicators, one can trace other changes in the market. Accordingly, a competent manager will always be able to make the necessary rearrangements and adjustments in his activities, the activities of his employees, pricing policy, and other indicators that directly affect the organization’s economic success.
- Production activity results depend on how timely and correctly the margin and profit will be estimated.
It is essential to use these two indicators at work to make the business successful.
There are a few things to keep in mind in the end. First, it is better to consider marginality as a percentage. The margin is calculated in currency, and the margin is calculated as a percentage. It is more convenient to analyze, watch the dynamics, and build graphs with them. Secondly, marginality shows the efficiency of the business. By marginality, you can see what share of the revenue is profit. The lower the margin, the less money you earn. Last but not least, the markup covers costs and affects the profit margin. With the help of markup, a business makes money, which can later be used to cover expenses and profits.
Author: Charles Lutwidge