Margin and markup are two closely related terms that sometimes generate confusion. Both are related to the pricing of items sold and how much of a sales price represents profit. Margin refers to the percentage of the sales price that is considered profit. Markup refers to a percentage added to the cost of an item to arrive at a sales price.
Companies need to think about margin and markup when pricing items to ensure that they are priced appropriately. If items are priced too low, the company will not make a large enough profit margin to cover the expenses of running business. On the other hand, a markup that is too high can be alienating to potential customers, who may seek out the same product at lower prices in other locations. These conflicting needs must be carefully balanced to find prices that appeal to consumers while satisfying the needs of the company.
To calculate profit margin, the cost of an item is subtracted from the sales price. The remainder tells people how much money was made on the transaction. This number is divided by the sales price to yield a percentage. For example, if a company is buying widgets for $100 United States Dollars (USD) each and selling them for $125 USD, they are making $25 on each transaction, and the profit margin is 20%.
For markup, a percentage of the cost is added to create a final sales price. In the example above, the markup is 25%. Note that the margin and the markup are different because different formulas are used to arrive at these numbers. Understanding the distinction between margin and markup is important when it comes to calculating pricing and profits. Many businesses develop a base formula they use to ensure that their prices meet their needs. For example, a retailer may decide to use a 50% markup, earning a 33% margin on each item sold. A key characteristic of margin and markup is that the markup percentage will be higher than the margin.
When considering how much profit needs to be made on each sale, companies think about all of the costs associated with doing business, ranging from paying for insurance to renting a facility. This is used to determine how much money would need to be made in order to break even. The company knows that it make more than this to turn a profit so that it can expand and the pricing is manipulated accordingly. Companies may also consider pricing tactics like discounts and sales, and structure their margin and markup to allow them to discount items while still making a profit.
