You don’t need to be an accounting expert to set prices that will support your business’s growth. However, a common mistake in estimating is assuming that markup and margin are interchangeable. This misunderstanding can threaten your profit and mislead your business goals. While both markup and margin can be used to calculate sales prices, knowing their differences is crucial for protecting your bottom line.

What is the Difference?
Did you know that a 30% markup will only yield a 23% profit margin? The key difference lies in the basic calculations.

Markup
Markup refers to the percentage added to an item’s cost to determine its sales price.

The formula for calculating your sales price using markup is:
Price = Cost x (1 + Target Markup %)

Example: If you purchase lumber for $100 and mark it up by 30%, the sales price will be $130.
$100 x (1 + 30%) = $130

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Margin

Margin is the percentage of profits you earn relative to your sales. Margin = (Price – Costs) / Price.

You may have already noticed that margin is a standard line item on your income statement, making it a great tool for measuring your business and project performance. Using the example above, your profit margin is only 23%. It is calculated as follows ($130 – $100) / $130 = 23.07%

The formula for calculating your sales price using margin is:
Price = Costs / (1 – Target Margin %)

Example
Using the example above, the sales price for the lumber using a 30% margin is $142.86.

$100 / (1 – 30%) = $142.86

Photo credit: JobTread

 

 

 

 

 

 

 

Why You Should Use Margin to Track Profitability

Knowledge is power, and understanding your actual and projected profit margins at all times is crucial for your business’s success.

Margin is an accounting measure found on your income statement that is used to evaluate profitability. By using margin, you can set business goals, track progress, and measure success by comparing the actual profit margin to the target margin at the project’s completion. If you fall short of your target profit margin, you can review the project details to identify errors, gaps, and overruns that may have impacted your bottom line, allowing you to make necessary adjustments before it is too late.

While using markup may seem simpler and more transparent to customers, it does not provide a comprehensive view throughout the project’s financial lifecycle. Relying on markup can hinder your ability to accurately forecast your gross profit, making it less effective for long-term financial planning and goal setting.