As a business owner, you might very well know “it takes money to make money.” But how do you make more money while spending less? That’s where a great business pricing strategy comes in.
A pricing strategy typically revolves around margin and markup—two similar ideas that result in different profits.
While margin and markup are often confused as the same, they have a few key differences. Let’s explore that right away before diving into specifics.
What Is the Difference Between Margin and Markup?
Margin refers to the profit you earn from each product, while markup is the additional amount you tack on to your product costs to get your final selling price.
For instance, say you sell a large pizza that costs $5 to make. A 30% markup means selling that pizza for $6.50. That’s because 30% of $5 is $1.50. So you mark up the product by that amount.
The math for figuring out your profit margin is a little different.
To find your profit margin, you use this formula:
Profit margin = (sale price - COGS) / sale price
That is:
$6.50 - $5 / $6.50
That equals 23%
While you marked up the product by 30%, your profit margin is 23%.
Margin vs. Markup Calculator
Aiming for a certain margin, but need to know what your markup should be? Use our calculator to find out. Besides giving you the markup percentage, it also helps you decide on the retail price of a product.
Or you can use the following formula to calculate the required markup from a desired margin percentage:
Markup = (Margin / (1 - Margin))
Say you need a 30% margin to match other restaurants. You can calculate the markup by plugging 30% into the above formula.
Markup = (30% / (1 - 30%))
Markup = (0.30 / (1 - 0.30))
Markup = 0.4285 or 42.85%
So to maintain a profit margin above 30%, you need a markup of 42.85% or higher on your items.
Some accounting software packages include calculators for converting margin to markup and vice versa as well.
You can refer to the markup chart below to quickly see how markup percentages compare to margin.
For example, the chart shows that while a 20% margin requires only a 25% markup, you need a 100% markup to enjoy a 50% margin.
Now that we answered your burning questions, let's dive deep into what these two important terms mean.
Ready to transform your business into a profit-pumping machine? Learn how with our monthly newsletter.
What Is Margin?
Margin is the percentage of revenue your company keeps after subtracting the cost of making the product. It shows how much money your business makes on each product sale compared to costs.
You may also hear of margin referred to as gross profit margin or gross margin. And you may find it on your business’s income statement.
How to Calculate Margin
The margin formula is (sale price - COGS) / sale price.
Calculate the margin by subtracting the cost of goods sold (COGS or cost price) from the selling price and dividing that number by the selling price.
COGS includes direct product costs like raw material expenses, product-related payroll costs, and relevant utility costs. For example, if you’re calculating the margin for a pizza, you’ll include the price of ingredients, the pizza chef’s wages, and the cost of electricity.
Example Margin Calculation
Say you own a pizza shop and want to calculate your margin for your large pizzas marked at a sale price of $14.99.
First, let’s calculate the cost of goods sold for the pizza.
Now that we have both the sales price and COGS, we can calculate the margin by plugging the dollar amounts in the margin formula:
Sale price: $14.99
COGS: $5
Margin = ($14.99 - $5.00) / $14.99
Margin = 0.6664 or 66.64%
In other words, for each $100 in sales, your pizza parlor makes $66.64.
But that doesn’t mean you keep all of that $66.64. Besides pizza chefs, you’ll also need to pay servers, cashiers, and delivery people.
Plus, you have to pay taxes, repay creditors, and pay all other business costs. Once you do all that, you get the net profit margin, which is your business’s bottom line.
You can also figure the gross margin for your small business by using total revenue and costs of goods sold instead of single item numbers.
However, if you manage a business where payroll costs aren’t cut and dry due to several people working on the same product, consider Hourly. Hourly’s time tracking features gather time and task data from your workers on the fly and help you organize it as you want.
What Is Markup?
Markup refers to the increase in the cost of a product to get the end price. For instance, if a product costs $50 to make and you sell it at $60, the difference between the two prices is called markup.
Typically, markup is expressed as a percentage of the cost of a product.
How to Figure out Markup
You can calculate markup by subtracting the costs of goods sold from the selling price and dividing that number by the cost of goods sold.
The formula is:
Markup = (sale price - COGS) / COGS
Example Markup Calculation
Let’s continue with our pizza example to calculate the markup.
Sale price: $14.99
COGS: $5.00
Plugging those numbers into the markup formula gets:
Markup = ($14.99 - $5.00) / $5.00
Markup = 1.998 or 199.8%
In other words, your pizza shop has a markup of 199.8% on each large pizza.
With the same dollar amount of $14.99, we got a 66.64% margin and a 199.8% markup. But what do these two metrics tell you? Let’s find out.
Margin vs. Markup: When To Use Them?
Why do we even bother to calculate margin vs. markup? Because both of these are accounting terms that give us information on our profitability.
When To Use Margin
The gross margin percentage tells you how much money your business earns by selling a product. If a product has a 25% margin, your business makes $25 for selling $100 worth of that product.
You can use margin percentage to compare your business’s product offerings. Say your pepperoni pizza generates a margin of 70%, and the veggie pizza returns a margin of 25%. You need to lower unit costs or raise the price of the veggie pizza to raise the margin.
Margin percentage also compares your business with its competitors. For example, NYU Stern found that the gross margin of restaurants averages around 30%. If you run a restaurant with a gross margin lower than 30%, your item costs might be out of line and you can look for discounts from suppliers.
When To Use Markup
You use markup percentage to decide the retail price of a product.
While markup percentage varies from industry to industry, you need enough markup to cover all the costs and make a profit without item costs being so high that people stop buying.
Does that mean markup and margin are directly related? Yes. You can use your desired margin to calculate the minimum markup rate you need to set on your products’ sale prices. Check out our calculator above to do just that.
Using Margin and Markup with Your Small Business
Both margin and markup are important accounting metrics that help you decide your product pricing. Still, you must account for the industry and local market in your price calculations since applying pizza’s 650% markup at your coffee shop probably means saying goodbye to your regular customers.
To make the most of margin vs. markup, start with NYU Stern’s data on gross margins, calculate the required markup on your products, and update your pricing to maximize profits.
