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Margin vs. Markup: The Difference Between Charging a Margin and Markup Percentage.

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If you buy inventory for $100, would you rather sell it to customers at a 20% markup or a 20% margin?  For everyone that said “Margin, duh!” you can stop reading right here because you probably already know what I’m about to write.

For those that hesitated even for a moment, however, I hope by the time you’re done reading this short article that you’ll never think about using the markup method ever again!

Allow me to elaborate.  A markup is just a factor used to add some cushion between what you pay for something and what you sell it for.  A 20% markup means you’re going to sell the item for 20% more than what you bought it for.  But what’s your gross margin?  20%, right?  Wrong.  I’ll explain in a moment.

Before illustrating proof about why margin-based pricing is always better than using a markup, let’s be clear about what margin-based pricing means; charging based upon a 20% margin implies that you’re going to charge the customer whatever price is necessary to generate a gross profit margin of 20%.  This not only always results in a higher selling price than a 20% markup, but also ensures you can more accurately predict the overall gross margin of your business.

Here’s the math, comparing the impact of margin vs. markup pricing:

 

 

 

 

 

 

 

 

 

 

By applying a 20% margin instead of a 20% markup, your sale price and profit are $5 higher than if you had used a 20% markup.  More importantly, your gross profit margin is 3% higher with a 20% margin versus a 20% markup.  Note that gross profit is a $ amount (Revenue – COGS), while gross margin is a % (Gross Profit / Revenue).

If you’ve historically used markup-based pricing, you’re not alone.  But you & your business could be doing much better with a margin-based pricing strategy!

This article was written by Brandon Hinkle, co-Founder of www.plurafinancial.com, the FREE online matchmaker between banks & small businesses seeking debt.   Click here for a glossary of more financial definitions & calculations.

Written by entrabanker

April 27, 2012 at 10:38 pm