All too often Mark-up is used interchangeably for Profit Margin
Knowing the difference will improve your PROFITS
How to avoid setting your mark-up so you lose money and have a negative margin!
Quick Definitions to help you clear this up once and for all!
Margin and mark-up are rooted in the same concept – both are ways of expressing what you get to take home at the end of the day; both can be expressed as either Dollar Values or Percentages. Their difference is the basis used for calculations:
* Mark-up – the amount added on top of production and purchase costs to create your selling price – the basis of this calculation are your expenses.
* Profit Margin – the proportion of the selling price that is profit – the basis of this calculation are your selling prices.
You can’t calculate margin without first establishing your mark-up
Profit Margins and Mark-ups
The easiest way to explain this is with an example – using something pretty basic… Let’s decide to run a cake stall at the local market – selling 10 cakes each weekend. OK so it wont make us millionaires, but it will help out the local school…
Having started with some maths we calculate every cake costs $5.50 in ingredients, and packaging.
Plus we need to add some tiny portion of our rent and electricity (by taking a guess of the cost), a small charge for our time baking selling and organising, and we want to print a few flyers that will cost $10 – we reckon all this costs about $50 in total each week so you work out this is $5.00 of overheads per cake…
TOTAL COSTS: That takes the total costs up to $10.50 per cake.
We then agree to sell our cakes at $15 each so:
* There is a $4.50 mark-up ($10.50 cost + $4.50 mark-up= $15.00 sales price) which is a mark up of 43% ($4.50 mark-up ÷ $10.50 cost price = 43% mark-up)
* There is a $4.50 profit margin ($15.00 sales price – $10.50 cost = $4.50 profit margin) which is a 30% profit margin ($4.50 mark-up ÷ $15.00 sales price = 30% profit margin)
So in this example if we stick to looking at the dollar values both the margin and the markup are $4.50 – the same and annoyingly confusing!
But the calculation of the Percentages differ because one is based on cost and one is based on profit. Using percentages is really important if you have several product lines and are making a change, or adding new products/services – don’t get caught out.
Profit Margin % x Cost Price ≠ Selling Price
In this example that exact calculation will only give a markup $3.15 instead of the $4.50
(ie $10.50 x 30% = $3.15, and $10.50 + $3.15 = $13.65 – not $15.00)
This is why it is so important to understand the difference between markup and margin; mix them up and you may rip yourself off!