Margin and markup are two terms that echo through the business community. They're also often confused with one another. Although margin and markup look at the same data, they look at it from different angles.
It's important to understand the differences between them to get an accurate depiction of your business costs and make wise business decisions surrounding service pricing. When you compare markup vs. margin, you'll find that the two are used for very different things.
What Is Markup?
Markup is a term that describes the total retail price consumers pay for a product minus its cost. Markup can include direct costs and indirect costs. For example, if you sell a subscription service for $50 per month that costs you $30 per month to fulfill, your total markup on that service is $20.
Markup isn't always expressed as a dollar amount, either. You can also express markup as a percentage. For example, saying you have a $20 markup on a product with a $30 cost is the same as saying your markup is 66.67%.
Formula and Calculation Method for Markup
The markup formula is as follows:
Markup Percent = Profit / Cost X 100%
Using the figures from above, say you sell a service for $50 that costs you $30 to produce. Your profit on that service is $20. Considering this information, your markup formula would look like this:
Markup Percent = 66.67% = $20 / $30 X 100%
To calculate your markup, divide your $20 profit by your $30 cost. The result of this calculation is 0.6667. Multiply that by 100, and you end up with a markup percentage of 66.67%.
How Markup Affects Pricing and Profit
Markup is a tool that business owners use almost exclusively as a pricing model. In particular, you can use markup to determine what your price should be if you want to produce a specific amount of profit from each sale.
For example, say you produce a service with a fulfillment cost of $20 per customer. You know that for your business to thrive, you need to operate with a 50% markup. Considering this, you can use the markup formula to determine what your price should be.
To do so, simply multiply your total cost by 50%. In this case, your markup should be $10, bringing the total price of your service to $30. The markup percentage formula further verifies this price:
Markup = 50% = 10 / 20 X 100%
What Is Margin?
Profit margin is a metric very similar to markup in that both figures look at the same data. In particular, the profit margin is the result of sales minus the product cost or cost of goods sold. For example, say you offer a service for $50 per month, and it costs you $30 per month to fulfill that service. Your margin is $20.
That seems similar to markup, and when you compare them in terms of dollar amounts, markup and margin are essentially the same thing. But something interesting happens when you express margin and markup as a percentage.
That's because the margin compares the profit of the transaction to the total selling price, while markup compares the profit of the transaction to the cost. Since the selling price is always more than the cost, the margin expressed as a percentage is always lower than the markup expressed as a percentage.
Formula and Calculation Method for Margin
The margin formula is as follows:
Margin = ((Sale Price - Cost Price) / Sale Price) X 100%
Keeping with the example above in which you offer a service for $50 that costs you $30 to fulfill, your margin formula would look like this:
Margin = 40% = (($50 - $30) / $50) X 100%
To complete this calculation, you simply subtract your $30 cost from your overall sale price of $50. This leaves you with a profit of $20. Now, divide your $20 profit by your sale price of $50. The result of this is 0.40. When you multiply this by 100, you end up with your total margin expressed as a percentage, or 40%.
Comparing the margin formula to the markup formula only serves to reiterate the fact that markup will always be larger than margin, as markup compares your profit to your costs rather than your profit to your overall selling price. In this case, the margin expressed as a percentage is 40%, while the markup is 66.67%.
How Margin Reflects Profitability
If you're an investor or you've ever attempted to attract investors to your startup, chances are you've read an income statement. Profit margins are an important part of income statements because they make it easy for business owners and investors to determine a company's profitability.
As a business owner, it's important to consider each product's margin to ensure that your profitability aligns with your margin goals.
Since the margin percentage is a percentage of sales revenue, it shows business owners and investors how well the company is performing in terms of turning money spent into money earned. The higher your margins are as a percentage of your overall sales revenue, the better your company is at converting cash on hand into profitability.
Key Differences Between Markup vs. Margin
Margin and markup aren't just different when it comes to how you calculate them. They also use data in different ways. When you understand those differences, you'll be better equipped to manage your profits and losses while building upon your company's financial health.
In terms of pricing strategy, markup is the clear winner. The markup formula makes it easier to determine what your price point should be based on the cost of your product and the overall markup you'd like to produce.
However, you can't count margin out when it comes to making informed decisions in terms of pricing strategy either.
Companies often look to product margins to determine if they're worthy of staying in production. For example, let's say you produce five different services. After about six months of sales, you run your profit margin numbers to find that four of your services are operating with a profit margin of between 35% and 40% while one of your services is operating with a profit margin of just 8%.
You may use this data to determine it's time to stop offering your fifth service. Instead, your company is better served when you focus your assets on the four services that produce more meaningful margins.
Although markup percentages are a great way to determine how to price your products, margins are the metric that leads the charge in terms of profit visibility. That's why profit margins are such prominent aspects of income statements, which investors use to determine if a company is worth investing in.
Profit margins are easy to understand since they're displayed as a percentage of sales revenue. For example, if a company has a 30% profit margin, it means that for every $100 that the company generates in sales revenue, it generates $30 in profitability.
The higher profit margins are, the more effective a company is at turning dollars spent into dollars earned. Moreover, as a business owner, it's important for you to keep track of the profit margins for each product you offer. Those with higher margins are your best performers, while those with lower margins may need further optimization.
When it comes to variability, markup and margins are two completely different things. Markup determines what a price point should be. Therefore, its variability is minimal once the markup is set on the product. Of course, you can change prices once a product is released, which somewhat plays into markup variability. Still, these figures are nowhere near as variable as margins.
Unlike markup, profit margins are determined after the sale of a product or service. It's expressed as a percentage of sales. However, sales come with a relatively significant level of variability. For example, some retail providers may offer your product or service at different prices. That, as well as coupons and other discounts coupled with potential refunds, play a role in your overall sales revenue.
With all of these factors coming into play, profit margins can be highly variable. Larger companies typically set profit margin goals and work hard each fiscal quarter to reach those goals.
Uses of Markup
The primary use of markup is to assist company owners and upper-level management in making informed pricing decisions. Companies can use the markup calculation to determine what the price of any product or service should be based on two simple factors:
- The Cost: This is the total cost the company incurs as a result of the production of the product or service.
- The Markup Percentage Goal: This is the goal markup the company has set for each product or service.
As a result, markup is designed as a forward-looking pricing model rather than a historical measure of profitability.
Pro Tip: Consider market conditions as you use markup to determine fair price points for your service. If market conditions are positive in your industry, you may be able to focus on higher markups. However, if market conditions are poor, you may need to offer a lower markup to gain a competitive advantage over others in your industry.
Uses of Margin
Operating margins and profit margins are essential figures that help you and your investors determine the overall financial health of your company. Profit margins are typically used in three ways:
- Financial Health Assessment: Profit margins help you and your investors determine the overall financial health of your company. If your company is producing high operating margins, it's likely to be in good financial health.
- Management Skills: Higher profit margins also suggest that you and your managers have great management skills. After all, if you're managing the company efficiently, the cost of producing your goods and services will be significantly lower than if your company's management is less efficient.
- Growth Potential: Companies typically use their profits to pay for things like increased inventory, marketing, and a growing team of employees. All of these factors help the company grow over time. As such, you have a high potential for growth within your company if you have a high profit margin.
Monitor Your Subscription-Based Business Profits With Ease
Do you know what your operating margins are? Are you reaching your margin goals? All of this may seem a bit convoluted, but it doesn't have to be. When you work with a strong subscription management partner, it's all handled for you.
Revolv3's full-stack payments platform actively works to increase payment approvals while reducing customer churn, ultimately increasing your company's margins. The platform is also equipped with a wide range of financial reporting tools so you can keep track of your performance and ensure that your company consistently hits its margin goals. Get in touch with Revolv3 today to find out how they can help you grow your recurring revenue.