Margin and markup are often mistaken or used interchangeably. Because you calculate both using the same variables and the two figures are closely related, it’s easy to mix them up. Understanding the difference between the two can give you a more complete understanding of your business so you can plan for long-term success.
Let’s compare inventory markup vs. margin, how they relate and what they mean for your business.
What Is Margin?
Often called “profit margin” or “gross margin,” this figure represents your revenue after deducting your business costs. While it can be written as a dollar amount, it’s often expressed as a percentage. For instance, a 50% margin means you sell your goods for double the cost to produce or purchase. Here, 50% of the total sales revenue is profit — hence “profit margin.”
Another way to think of this figure is as a monetary value. At 60% margins, a company profits $0.60 on every sales dollar. The other $0.40 covers its expenses.
The Profit Margin Formula
When calculating your margins and your markup, you’ll need to understand three variables:
- Revenue: This is the income earned from a sale before making any deductions. It does not account for any business expenses.
- Cost of goods sold (COGS): COGS combines all the expenses your business incurs while making, buying, storing and transporting your wares. COGS includes any variable costs that you can directly attribute to the goods, such as raw materials, manufacturing, labor and freight. It does not include fixed costs like rent, utilities or back-office staff. Finale Inventory can calculate your average acquisition cost per item using our product landed costs capabilities.
- Gross profit: Your gross profit margin is the monetary value of your revenue minus your COGS. For instance, if your COGS is $40,000 and your sales revenue is $70,000, your gross profit margin is $30,000.
You’ll have to know your revenue and COGS to use the profit margin formula. If you’re a Finale Inventory customer, you can pull this data directly from your accounting reports in Finale Inventory. If you’ve integrated with your QuickBooks account, you can find it there. The profit margin formula is revenue minus cost divided by revenue, or (Revenue – Cost) / Revenue = Margins.
For example, let’s say you sell jackets for $100 each, and it costs you $60 per unit to purchase them wholesale. To calculate the margins, you would subtract $60 from $100 to get $40 and then divide that figure by $100 to get 0.4. To make things even easier, Finale Inventory will calculate your margins automatically with our built-in gross margin report.
Raising Profit Margins
Margins can vary a lot by industry and business model. In the jewelry segment, profit margins average 62.53%, while the margins are around 41.46% for sporting goods. Some businesses thrive on tight margins with high sales volumes, undercutting their competition by selling goods barely above their cost. Other companies enjoy healthy margins where they can sell products well above the wholesale price. Profit margin is a critical figure in understanding a company’s financial health because it tells us whether the business is profiting from its sales. Margins can also indicate how efficiently the company optimizes its costs.
Companies can use two strategies to boost their margins. The first is to increase the price, which usually lowers sales. The second is to reduce the COGS by either using volume discounts or making internal inventory processes more efficient.
What Is Markup?
Markup measures profit from a sale, just like margin. The difference is that markup looks at the profit as a percentage of the COGS rather than the revenue. It’s the portion of your acquisition costs that you add to the selling price to achieve a profit. If you place a 50% markup on a $10 item, you’ll sell it for $15. At a 100% markup, you’ll sell it for $20.
The Markup Formula
As with calculating your margins, you’ll need to know your revenue and COGS. Once you pull these figures from Finale Inventory or however you track this data, you can insert them into the markup formula. The markup formula is revenue minus COGS divided by COGS, or (Revenue – COGS) / COGS = Markup. This equation lets you calculate the markup applied to goods you’ve already sold, expressed as a ratio. You can multiply that ratio by 100 to express it as a percentage.
Let’s return to the example of the $100 jacket you bought for $60. Your markup would be equivalent to $100 minus $60 divided by $60, or ($100 – $60) / $60 = 0.67. Expressed as a percentage, that’s a markup of roughly 67%.
Another way to use the markup formula is to calculate the price you should set given a predetermined markup. This calculation uses the formula COGS multiplied by markup plus COGS equals the retail price you set, or (COGS x Markup Ratio) + COGS = Price.
With the jacket example, let’s say you’ve purchased it for $60 and want to determine your retail price. In the fashion industry, the typical markup ranges from 55%-62%, so let’s say you’ve landed on an even 60% markup, or 0.6. You’d calculate your retail price by multiplying $60 by 0.6 and adding another $60 to get $96.
Setting Appropriate Markups
Typical markups can vary a lot by industry. For example, the clothing industry can enjoy markups as high as 100%, while the automotive sector usually assigns markups of 5%-10%.
If you’re a Finale Inventory user, you can set your own markup in our sophisticated software using pricing formulas. This will apply a standard markup to your products, which you can adjust for particular customer segments. It allows your sales price to fluctuate automatically with your current COGS, keeping you in line with market rates. When your supplier’s price goes down, yours follows suit. When it goes up, you can maintain steady profit margins. All the while, you ensure every item you sell nets a profit.
Understanding the concept of markup is critical because it ensures your sales generate profits.
By adding a markup, any sale will cover the product’s incurred expenses and then some. Analyzing markup is especially important as a fledgling business because it helps you understand your cash flow. You’ll keep a careful eye on your fluctuating COGS, helping you optimize expenses.
Margin vs. Markup Key Differences
In many ways, margin and markup are two sides of the same coin. They both require COGS and price or revenue inputs, and both figures help sellers understand and optimize profits. However, they have some crucial differences.
The biggest distinction between margin vs. markup is that a markup has a direct influence on your margins. When you mark up the item’s cost, it affects sales revenue, which directly impacts margins. The higher the markup, the wider the margins. However, it’s not a one-to-one relationship. While a 15% markup translates to a 13% margin, a 100% markup translates to a 50% margin.
Let’s compare profit margins vs. markups head to head.
Markups:
- Refer to the added cost the customer pays in addition to the COGS.
- Can sometimes overestimate profits.
- Are easier to use and understand and are usually considered before analyzing margins.
- Can be either set by the seller or calculated after the sale.
- While less common, can be set above 100% — a product with a 200% markup sells for triple its cost.
- Ensure every item you sell is netting a profit.
Whereas margins:
- Analyze the monetary business value of a sale and show how all sales impact the company’s bottom line.
- Are more accurate than markups because they rely more heavily on the cost of goods
- Are calculated after the sale.
- Will never be more than 100% because they always express the portion of the final sale that a business keeps as profit.
Learn More About Finale Inventory
Understanding your margins and markups is critical to ensuring consistent profitability. Finale Inventory helps you track your financials, margins and markups quickly and easily through our inventory accounting and reporting suite.
By tracking everything about your inventory, from the quantities you have in stock to your sales and purchasing history, we let you quickly understand your business with quick and easy custom financial reports. With these tools, you can maintain a healthy, profitable business for years to come.
As an inventory management solution to make you more efficient and save money on your inventory operations, we help you grow your business, lower your COGS, improve customer relationships and much more. To learn more about everything Finale has to offer, sign up for a demo today!
