As a businessperson, you must set prices for goods and services you provide. You also have to analyze prices and costs to insure your pricing is sufficient to produce a profit, but not so high you’ll lose sales to competitors. Markup and margin are distinct, but closely related measures that help you accomplish these tasks.
Cost of Goods
Before you can calculate either markup or margin, you must compute your cost of goods (or services). Cost of goods is the direct cost of providing a product or service and does not include indirect costs such as rent or administrative expenses. For a retail business, determining cost of goods usually is straightforward. Cost of goods is simply the price you paid your supplier for the product plus an allowance for loss or breakage. By contrast, the cost of a product for a manufacturing concern can be complicated. You have to include the cost of raw materials, spoilage and production labor.
Markup is a percentage of the cost of a good that is added to the good’s cost to set a price. For example, if an item costs $15 and the markup is 80 percent, you would add 80 percent of $15--or $12--to the $15 cost for a price of $27. Many businesses use markup formulas. This simplifies routine pricing and helps maintain a consistent pricing policy.
Margin--sometimes called gross margin or gross profit margin--is the percentage of a product’s price that remains after the cost of goods is subtracted. In other words, this is the proportion of the price available to cover overhead and provide a profit. To calculate margin, subtract the cost of the item from its price, and divide the result by the price. If the price is $27 and the cost of the product is $15, you have ($27-$15)/$27, which equals 0.444. Multiply by 100 to convert to the margin percentage of 44.4 percent.
Sometimes you may want to convert markup to margin or vice versa. To convert markup to margin, first state the cost of goods as 100 percent and add the markup percentage. Divide the markup percentage by this figure to convert to margin percentage. For instance, if the markup is 80 percent, you have 80 percent/(100 percent + 80 percent), which equals 0.44. Multiply by 100 to arrive at 44.4 percent margin. To convert margin to markup, divide the margin percentage by 100 percent minus the margin percentage, and then multiply by 100. Thus, if the margin percentage is 44.4 percent, you have 44.4 percent/(100 percent - 44.4 percent) times 100, which equals 80 percent.