Markup vs Margin Differences

Markup and profit are not the same and the accounting for margin and mark-up are different. A clear understanding and application of the two within a pricing model can have a drastic impact on the bottom line. Terminology speaking, markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit.

Many mistakenly believe that if a product or service is marked up, say 25%, the result will be a 25% gross margin on the income statement.

However, a 25% markup rate produces a gross margin percentage of only 20%.

How to calculate markup percentage

By definition, the markup percentage calculation is cost X markup percentage, and then add that to the original unit cost to arrive at the sales price.

Not quite the "margin percentage" we were looking for. So, how do we determine the selling price given a desired gross margin? It's all in the inverse. of the gross margin formula, that is. By simply dividing the cost of the product or service by the inverse of the gross margin equation, you will arrive at the selling price needed to achieve the desired gross margin percentage.

 Markup vs Gross Margin; Which is Preferable?

Though markup is often used by operations or sales departments to set prices it often overstates the profitability of the transaction. Mathematically markup is always a larger number when compared to the gross margin. Consequently, non-financial individuals think they are obtaining a larger profit than is often the case. By calculating sales prices in gross margin terms they can compare the profitability of that transaction to the economics of the financial statements.

Steps to minimize Markup vs Margin mistakes

Terminology and calculations aside, it is very important to remember that there are more factors that affect the selling price than merely cost. What the market will bear, or what the customer is willing to pay, will ultimately impact the selling price. The key is to find the price that optimizes profits while maintaining a competitive advantage. Below are steps you can take to avoid confusion when working with markup rates v margin rates:

• use a pricing model or pricing tool to quote sales. Have the tool calculate both the markup percentage and the gross margin percentage

• relate gross margin percentage per sales invoice to income statement

• organize your chart of accounts to compare gross margin rate to sales quotes

• educate your sales force on the differences. By targeting the gross margin percentage vs the markup percentage you can throw an additional 2 - 3 percent profit to the bottom line!