Difference Between Margin and Markup
The key difference between Margin and Markup is that margin refers to the amount derived by subtracting the cost of the goods sold of the company during an accounting period with its total sales, whereas, the markup refers to the amount or percentage of profits derived by the company over the cost price of the product.
The first & foremost step in determining the profitability of a firm is defining the pricing structures of its products. This can be realized by understanding the margin and markup as these numbers play an important role in determining the revenues & bottom line in the financial statements.
- Margin (more popularly known as gross-margin) in simple terms is revenue minus the cost of goods sold (COGS). For example, if a product sells for $500 & costs $400 to produce, its margin would be calculated as $100. If expressed in percentage terms, the margin percentage will be 20% (calculated as the gross-margin divided by total sales i.e. 100/500).
- Markup is the amount that should be added to the manufacturing cost of a product to derive the price that it should be sold at. Continuing with our above example, a markup of $100 from the cost price of $400 yields the $500 price. Or, stated as a percentage, the markup percentage is 25% (calculated as the markup amount divided by the product cost i.e. 100/400).
As illustrated in the example above, both are different accounting terms that provide two different perspectives of looking at business profit. When expressed as a percentage of sales, it is called profit-margin but if expressed as a percentage of a cost it is called Markup. These are like two sides of a coin – different & yet closely related.
Margin vs Markup Infographics
Key Differences
The key differences are as follows –
#1 – How are they different?
Much like the analogy of cup being half full or half empty, margin and markup are two different outlooks on the relationship between price and cost. A margin is more with respect to sales & markup is more with respect to a value derived on the manufacturing cost. Both have their own significance in financial statement analysis
- Markup ensures that you are making profits & quantifying that profit each time you sell a product.
- Markup is essential during the initial phases of business as it helps you understand the cash inflows and outflows. This can help in identifying the efficient points & the bottlenecks in the business.
- A margin is a reliable & precise way of calculating the profits & clearly highlights the impact your sales have on the bottom line.
#2 – Perspective
In absolute terms, margin and markup refer to the same numeric value. However, the perspective makes them all together with a different concept. Refer to the diagram below for our earlier example:
When looked from the view of a seller, the $ 100 value is a margin but when looked from the viewpoint of a buyer the same $100 is markup. However, in percentage terms, the two figures are quite different.
#3 – Relationship
The concept of margin and markup can be confusing while deriving pricing and if not investigated properly can affect your profitability. Since the reference for calculating markup is cost price it will always be greater than the margin, the basis of which is always a higher value – selling price. As a thumb rule, the markup percentage must always be higher than the margin percentage else you are making losses in the business.
The markup calculation is more likely to impact pricing changes over time than a margin-based price. This is due to the fact that the cost upon which the markup number is based may differ with time; or its calculation may vary, resulting in different costs which would, therefore, lead to different prices.
The following bullet points illustrate the differences and the relationships between the margin and markup percentages at distinct intervals:
- To attain a 10% margin, the markup percentage should be 11.1%
- To attain a 20% margin, the markup percentage should be 25.0%
- To attain a 30% margin, the markup percentage should be 42.9%
- To attain a 40% margin, the markup percentage should be 80.0%
- To attain a 50% margin, the markup percentage should be 100.0%
To derive a general markup percentage, the expression would be as follows:
For example, if the manufacturing cost of a product is $100 and you want to earn a margin of $20 on it, the calculation of the markup percentage is:
$20 Margin ÷ $100 Cost Price = 20 %
If we multiply this $100 cost price by 1.20, we arrive at a price of $ 120. The difference between the selling price $120 and the $100 cost price is the desired-margin of $20.
#4 – Which is preferable?
They try to present a different perspective on the same financial status. However, at any point in time markup is always greater than gross-margin and hence it overstates the profitability of the firm. Due to this reason markup is most often preferred as a reporting mechanism by the sales and operations department. For any person with a non-financial background, it will look like a transaction is obtaining a larger profit if they are presented with Markup numbers than corresponding Margin numbers.
Margin vs Markup Comparative Table
| BASIS | MARGIN | MARKUP | ||
| Significance | It is technically a profit-margin, that measures the profitability of a firm. It is the proportion of the income that has been left over in the business after the cost of production has been paid out from revenues. | It refers to the value-added by a seller to the cost price that covers its production costs and profits, in order to arrive at the price that a finished product can be sold at. | ||
| What is it? | Numerically, it is a percentage of the selling price. | Numerically, it is a cost multiplier. | ||
| Defined as a Function of | Sales | Cost | ||
| Expressed from the Perspective of | Seller | Buyer | ||
| Mathematical Formula | (Selling price – Cost price) / Selling Price | (Selling price – Cost price) / Cost price | ||
| Relationship | Margin = 1 – (1 / markup) | Markup = 1 / (1 – gross margin) |
Conclusion
Getting to understand the relationship between margin and markup is vital for a business. Do the math wrong and you may end up losing money without even realizing it. On the other hand, if done right it can help in planning and implementing your long term and short term strategic initiatives like planning for more penetration in the market or cross-selling to your existing customers.
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