It’s essential for any business to set prices so that there is enough left over after paying for the cost of its products to cover operating expenses and make a profit. Markup and gross margin are two tools you can use to determine prices and analyze your pricing structure. They are interrelated concepts, and you will sometimes need to convert from one to the other.
Markup and Gross Margin Explained
Markup is the percentage a business adds to the cost of an item to set a price. Suppose a retailer pays $30 for a pair of shoes and adds a 60 percent markup. The dollar amount equals 60 percent of $30 or $18, so the price is $48.
Gross margin, also called gross profit margin, is the proportion of the price that is left over after subtracting the cost a good from the price. For the $48 pair of shoes, the $18 difference between the cost and the price works out to 37.5 percent of the price.
Markup to Gross Margin
To convert markup to gross margin, first calculate the dollar value of the markup, then divide by the price. Suppose the shoe retailer markets a discount shoe style that costs $10. The markup is 60 percent, so the markup is $6 and the price is $16. Divide $6 by the $16 price and the gross margin comes to 37.5 percent.
Gross Margin to Markup
If you want to convert gross margin to markup, first multiply the gross margin percentage by the price to find gross margin in dollars. Subtract the dollar value from the price to calculate the cost of the item. Divide the gross margin in dollars by the cost and multiply by 100 to state the markup percentage.
Take the $16 pair of shoes with a 37.5 percent gross margin. Multiplying $16 by 37.5 percent gives you $6. Subtract $6 from the price to calculate the cost of $10. Divide $6 by $10 and multiply by 100 and you have the markup of 60 percent.