Growing your own small business or online wholesale store is an incredibly rewarding and exciting experience. But if you’re someone who isn’t super familiar with business lingo and marketing terminology there might be some things that leave you scratching your head. You may hear the terms like markup vs. margin, but what do they mean, and why are they important?
Simply put — both the profit margin and markup are two parts of the same transaction. The profit margin shows profit as it relates to a product’s sales price or the amount of revenue generated, while the markup shows the profit as it relates to costs of goods sold.
Markup and margin are both accounting terms that you’ll regularly come across as you operate the financial side of your business.
- What Is a Margin?
- What Is a Markup?
- Why Is It Important To Know The Difference Between Markup vs Margin?
- What is an Example of a Markup vs Margin?
- What is a Gross Profit Margin, Operating Profit Margin, and Net Profit Margin?
- How To Calculate a Good Profit Margin?
- What is a Good Markup?
What Is a Margin?
In sales, the basic principle is that businesses must sell a product for more than it costs to make or manufacture — this is how you make a profit. This difference between the price you purchase or manufacture the product and the price you sell it for is referred to as the profit margin. Another way of phrasing this is that the margin refers to a business’s revenue after paying the cost of goods sold (COGS).
As you run your business, you will probably come across three types of profit margin. These are the gross profit margin, operating margin, and net profit margin. We will go into more detail about what each of these means below.
The profit margin formula is:
- Profit Margin = Net Sales / COGS * 100
What Is a Markup?
A markup is the amount by which the cost of a product is increased to get to the final selling price. For example, if you purchase or manufacture something for $80 and sell it for $100, you have made a profit of $20. The percentage of profit ($20) to cost ($80) is 25%. This would give you a 25% markup on your product. The markup price is related to the profit margin, but they are not the same thing and can be confused.
The markup can be calculated by an equation.
- Markup = Profit / Cost * 100
Why Is It Important To Know The Difference Between Markup vs Margin?
It’s really easy to see how you can confuse the profit margin and the markup, and errors in mixing up the two can lead to business owners either undervaluing or overpricing their products, which can impact your profit and the success of your business. It’s important to understand exactly what the two mean and how they affect your bottom line so that you can price your products effectively.
There are a lot of administrative tools available online, including Profit Calc and BeProfit, which are designed to make accounting easier and more efficient.
What is an Example of a Markup vs Margin?
Both the profit margin and markup are two parts of the same transaction. The profit margin shows profit as it relates to a product’s sales price or the amount of revenue generated, while the markup shows the profit as it relates to costs of goods sold.
If it cost a vendor $50 in materials and labor to make a beautiful rug, and they sold that rug for $80 on Handshake, the profit margin would be $30. Calculated into a percentage would give you a margin of 37.5%.
Using the same example of the rug, the markup is the difference between a product’s selling price ($80) and its cost price ($50) – the markup price is $30 – but looking at the equation from a different perspective (with a percentage that is calculated by dividing markup price by what is the cost to make the rug), the markup percentage is 60%.
What is a Gross Profit Margin, Operating Profit Margin, and Net Profit Margin?
The example above uses what is referred to as a gross profit margin, which in our example is $30 or 37.5%. This means that the profit margin includes the total sales revenue before deducting any tax or other expenses. Most businesses will use the gross profit margin to provide crucial insights into how effectively they use their resources to make and sell goods or services.
The operating margin includes the costs of products sold, costs associated with selling and admin, and the overhead. It’s important because the operating margin measures how much profit a company makes after deducting variable costs. These include manufacturing costs and wages if you employ people. This margin will help investors analyze a company’s value and profitability.
Lastly is the net profit margin. This margin percentage is calculated after deducting all expenses and taxes from the business’s overall revenue, and it is then divided by net revenue. The net profit margin – also referred to as the bottom line – is a very important margin for indicating a company’s overall financial health and ability to grow.
How To Calculate a Good Profit Margin?
So you have a product you’re proud of, and you’re ready to sell it online–how do you calculate a healthy net profit margin? A good margin will vary considerably depending on the industry and size of the business. That said, it is generally thought that a 10% net profit margin is considered average, while 20% is high (or “good”). A 5% net margin is considered low.
It’s important to consider that this is simply a guideline and may not apply to your products or services. It’s also important to note the percentages for your gross, operating and net profit margins will vary because they represent different areas of the business.
You can use Shopify’s wholesale profit margin calculator to help you figure out what the best profit margin should be for your business.
What is a Good Markup?
In the same way that there is a general rule of thumb for looking at profit margins, the same goes for calculating the markup. Most companies will set an average retail markup — also known as a “keystone”– of 50 or 60%, but it really depends on product and industry. Luxury goods will have a much higher markup, while small kitchen appliances, for example, tend to have a lower markup. Your markup percentage may also vary as your business grows.
When figuring out how high or low your markup percentage should be, here are some basic principles to consider:
- If you have low prices, then your markup percentage should be higher.
- If you can produce and sell inventory quickly, you should have a lower markup.
- Everyday products should have a lower markup than unique, one-off items.
- Take a look at your direct competition: what are their markups?
While it might be tempting, having a high markup isn’t beneficial, especially when you’re growing your small business. It might deter customers, and you might struggle to sell anything at all. Setting your markup price too low, and you’ll barely be making any profit at all. This is why 50% is considered a safe bet – it ensures you are earning enough money to cover the costs of manufacturing while also earning a healthy and steady profit.