This is my entry for ‘most mind-numbingly tedious post of the week’, and I reckon I’m onto a winner. However, there is a serious point to it, because people can often be confused about the distinction between markup and margin, so this post tries to clear that up and explains why it matters to get it right!
Markup and margin are often quoted as percentage values, and this contributes to the confusion.
I prefer to think of margin as a percentage, but markup as a multiple. I think it’s clearer, but let’s just clarify that slightly but, before we do, note that VAT is not part of any margin calculation, although it may apply to a markup. All the calculations I mention below will make this clear (I hope!)
The margin is the profit …
The margin is simply the profit made on a sale – the simple difference between what it cost me and what I sold it for. Remove VAT from both cost and selling prices, if applicable, before doing this sum.
We can all agree that if I sell something for £100 and it cost me £50, then I have made a 50% ‘profit’ or margin – half of the final selling price.
Note that if you forget to remove the VAT, then your profit percentage still appears to be 50% (the difference between £60 and £120) but the profit amount then looks like £60, which is incorrect as the extra tenner belongs to the VAT man, hence the need to remove the VAT and use net figures only.
The markup is the multiple …
I find it less confusing to talk about markup as a multiple – if I’m doubling my cost price then I’m marking up by 2.
The simplest way to work out the markup is to divide the selling price by the cost price so here 100/50 gives you 2
You may need to allow for VAT, so to double your net cost price and add 20% VAT to the selling price, you need to mark up by 2.4. So your £50 item sells at full retail for £120.
Get the VAT right …
By the way, don’t fall into the trap I sometimes come across of taking 20% off the price – taking 20% off 120 will give you 96 as opposed to the correct value of 100 so you will understate your margin and also end up being hauled from your bed at 05:00 one morning by a VAT raid. Well, perhaps not the last bit.
The correct calculation to remove the VAT from a price is to divide it by 1.2 (assuming VAT at 20%), therefore 120 / 1.2 = 100.
If you want the amount of VAT itself then the way I like to do it is to remove the VAT as above and then take 20% of the remaining (net) value, so 120 / 1.2 * 0.2 = 20.
Know how much money you are making!
So margin is critical, and you don’t need to be an accountant to get to grips with it. It’s very straightforward and a good thing to be thinking about every time you price a product or service. You need to know what your costs are, and then monitor margin to find out what is worth selling more of (or indeed worth selling at all).
You may want to use margin calculations as a way of deciding which customers or jobs are actually not generating any real income for you. Other revenue streams will be highly profitable, so you need to concentrate on building those, while perhaps even going so far as to drop unprofitable customers.
If you supply consumer goods online, then typically these are high-margin sales as you are selling direct to your customer, and not via a retailer or middle-man, who will be taking their own share of the margin. So your e-commerce website is generating a far better margin than your wholesale business.
You may think this is all very obvious, but I say again – you would be surprised by the number of people who make errors in these calculations, and who can end up giving money away one way or another, and none of us are in business to do that!
Aside from markup and margin, do you have any other handy tips and tricks for simplifying important business calculations?