Margins and markups What everyone in business needs to know.

Posted on Thu 06 December 2007 in Business

Quick answer in words (requested from the comments)
Margin = The comparison between your selling price (100%) and your profit
Markup = The comparison between your cost price (100%) and your profit

Every time we get a new member of staff I have to teach them how to work out margins and mark ups. This page is here so I don't have to explain it from scratch for the next new person.

Whats a mark up & whats a margin?

They are terms given to the way a business works out how much money it will make or has made on a product. Its the difference between the buying price and the selling price as a percentage.

Mark ups and margins are all about percentages. Despite learning percentages at school everyone seems to have forgotten them by the time they get to work, so lets start at the beginning:

What is a percentage?

Percentages are away of comparing different values using a ratio. I think it comes from the French phrase ''Per Cent'' meaning "per hundred"
Example time
It you have a 100ml jar that is full (100ml) it is at 100% capacity and 100% of its volume. If it is only half full (50ml) it is at 50% capacity and 50% of its volume. Easy so far.
You choose where your 100% begins and thats where many people start to get confused. Lets say I wanted to put a chemical in my jar and the safe maximum level was 50ml. It I fill the jar to 50ml it is now at 100% capacity. It l over fill it to 75ml it is now at 150% of its safe capacity yet at the same time only 75% of its volume.

How do we work that out?

  1. throw away your Calculators % button. It is only there to confuse you!
  2. Start with 100 and divide it by your unit of measure that is 100%.In the above chemical jar example 100% safe capacity was 50ml So 100 / 50 = 2
  3. Multiply by the actual unit of measure you have. In the example above, our overfilled jar held 75ml so 75 * 2 = 150, which is your answer as a percentage, the chemical jar was at 150% of its safe capacity.

Now we know about percentages, let's apply that to mark-ups and margins

To do this I first want to tell you percentages best kept secret!
100% of 1 is 1.
50% of 1 is 0.5.
So to turn a % into a decimal just move the point two places to the left
75% becomes 0.75,
62.5% becomes 0.625
(or if you get very scared by not using the calculator, just divide by 100. 100 / 100 =1 , 50 / 100 = 0.5, 75 / 100 = 0.75)

Mark ups and margins are all based around percentages.
Lets start with a mark up calculation.
You are given a buying price (50) and told to mark up by 50%

50 * 0.5 = 25 euros
Add them together 50 + 25 = 75

Lets try that with Britains most popular mark up, VAT (Value Added Tax for my friendly non British readers). VAT is (at the time of writing) 17.5% added to the selling price of many products and handed to the government to pay for part of running the country.

17.5% as a decimal is 0.175
50 * 0.175 = 8.75
Add them together 50 + 8.75 = 58.75

It gets better though, if you want to know only the total including vat you can take a shortcut. 100% = 1, 17.5% = 0.175, added together 1.175, so
50 * 1.175 = 58.75
In other words, our total including the VAT mark up is 117.5% of our starting point. Our starting point is the price without the vat (100%).

One more example then, 66 + a 50% markup in one go:
66 * 1.50 = 99.

What about taking off a markup? Lets say you've been given a book of retail prices including VAT and you have to load them onto a computer without VAT. It's simple when you remember the VAT total is 117.5% because division ( key: / )is the opposite of multiplication ( key: * ). Note, on your calculator it looks like 34-dividekey.jpg.

58.75/1.175 = 50

Remove our 50% mark up
99/1.5 = 66

Be careful! This only works when you have more than 100% to begin with. Eg, you cannot do 99/.5 to find out what the 50% was, 99/.5 = 198!

So, with a mark up our starting figure (eg cost) is 100%. You can have a markup of any value, eg 300%

Now for margins

With a margin our ENDING figure is 100%. You can never have a margin equal or greater than 100%

Sometimes you'll be given a selling price (eg recommended retail price, RRP) if you have 33% margin, what price do you put on your purchase order? (in this case, margin is our profit).

50x0.33= 16.50
Which is our profit, so 50 - 16.50 = 33.50 Our buyingprice

Again we can shortcut this to find our cost price. If we know that if 33% is our margin then 67% must be our buying price, so 50x0.67 = 33.50

What about when we have a buying price. A margin of 33% and we need to knew the selling price?
We know that if our margin is 33%, our cost must be 67% (our selling price with a margin calculation must always be 100% so 100% - 33% profit margin = 67% for the cost).
We can divide our cost price by the cost percentage to return to 100% selling price, eg:
33.50 is 67% of our 100% total, so
33.50 / 0.67 = 50

Still with me on this?

Lets try comparing some mark ups and margins and see what happens.
A sales rep once said to me "You'll make more selling my product because the price list I give you has a 50% profit; everyone else is using 40%."
The trouble is he was talking about profit as a mark up calculation in his book and everyone else was talking in margins.
A £75 product in his book had a profit of £25

(Using mark up: selling price = 150% of cost price, cost price = 100%, so £75 / 1.50 = £50 cost, therefore £25 profit).

A £75 product in everyone elses book had a margin of £30

(Using margin: selling price = 100%, margin = 40%, therefore £75 * 0.4 = £30 profit)

So, a 40% margin is better than a 50% mark up.

Heres one for people who arent in business.

Have you ever been tempted by the banners proclaiming "Sale prices - Well pay the 17.5% VAT"? Great! A 17.5% discount. right?
Thats what the marketing department want you to think, but as you now know, VAT is a markup calculation so to arrive at the excluding VAT price you DO NOT deduct 17.5%. Lets work out what the real discount is, assuming our 2 fictitious bargains are £100 for the Kanga and £117.50 for the Roo respectively, including VAT. Lets remove the VAT the right and wrong way.

A VAT inclusive price is 117.5% of our original price, so:
Kanga: £100 / 1.175 = £85.11
Roo: £117.50 / 1.175 = £100.00
are the correct after VAT removed prices.

Lets assume the marketing department sent the wrong poster to be printed:
"Save 17.5%, buy our Kanga and Roo today" it proclaimed.
17.5% as a decimal is 0.175 (simply move the decimal two places like we said earlier)
Kanga: £100 * 0.175 = £17.50 discount = £82.50 left to pay
Roo: £117.50 * 0.175 = £20.56 discount = £96.94 left to pay

Thats right, if the sign proclaims you save 17.5% - it's wrong, you actually save
(working this out using the same process as above so you see how it works again):

  1. throw away your calculators % button. It is only there to confuse you!
  2. Start with 100 and divide it by your unit of measure that is 100%. In the above, 100% of the VAT inclusive price was 100 for Kanga So 100 / 100 = 1
  3. Multiply by the actual unit of measure you have. In the example above, our after VAT price is 85.11 so 85.11 * 1 = 85.11

We know 85.11% is our before VAT price, so VAT content was 100% - 85.11% = 14.89%

I guess Save 14.89%, buy our Kanga and Roo today just doesnt have the same ring on a poster.

~~By the way, if you're wondering why i used \$ instead of £, I wrote most of this entry on a Coach travelling through france and it was simply quicker to write on my PDA :-)~~ * Corrected!*