Markup vs. Margin – What’s the Difference?
Businesses use various models to determine the size of the markup, but the principle is the same in all cases.
- Find the cost of an item. Before you can calculate markup and margin, you must know the product’s cost. The cost includes the price paid for an item or materials plus the labor required for processing. Additional expenditures, such as breakage or spoilage, may also be counted as part of cost.
- Multiply the cost by the percentage of profit you’d like to make on the product and add the result to the cost to arrive at the price. If you are using a markup of 75 percent and the cost of an item is $10, the dollar value of the markup is 0.75 (75 percent) times $10, or $7.50. Add this to the $10 cost to arrive at a price of $17.50.
- Calculate margin by subtracting the cost from the price and dividing the remainder by the price. For example, if an item is priced at $25 and the cost is $15, first subtract $15 from $25, leaving $10. Divide by $25 for a profit margin of 0.40. Margin is the proportion of a price in excess of cost and is usually expressed as a percentage, so multiply by 100 to get the percentage. In this case, the margin would be 40 percent.
Cost vs. Price
People often interchange price and cost, but it’s important to recognize the significant difference between the two. Remember the old adage, “Beware the cost of the lowest price?” Well, it rings true. Just because a product is less expensive than its competitors’, doesn’t mean you (or your business) save money in the long run. Sometimes, perhaps most times, you end up spending more in part because of time and efficiency lost to a mediocre product. Or, you could potentially spend twice as much as you’d originally hoped because you have to buy a replacement for that first purchase.
So what’s the difference between ‘cost’ and ‘price’?
Price = The sticker price of what you’re buying.
Cost = What you stand to lose in time, efficiency, problem-solving, etc. if you don’t consider your return-on-investment.
And that’s what it comes down to for most major purchase decisions: return on investment. Where do you stand to gain the biggest bang for your buck? For businesses, the point of purchasing a product should be how it improves a process or system. In the end, if there is significant cost-savings in personnel time or improved staff efficiencies, it’s worth the extra money up front for the long-term benefits.
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