Lots of people get terribly muddled about the difference between mark-ups and margins.

Mark -ups

Think of a mark- up as the amount that you add to the price you have paid for your product to get to the selling price.

So you might say I am going to mark up this teapot by 100%. This means that if the teapot cost you $10 you are going to add to on another $10 to get the selling price.  The selling price is $20, the mark up is $10 and the mark-up percentage is 100% of the original cost

Alternatively you might mark-up the teapot 50%. This means that if the teapot cost you $10 you are going to add on another 50% of the cost ($5) to get to the selling price. The selling price is then $15, the mark-up is $5 and the mark-up percentage is 50%.

If you like formulas, the formula to calculate the mark-up percentage is this:

(Selling price - cost price)/cost price

Gross Margins

Mark-ups are useful when your starting point is the cost. But often you want to look at your revenue figure and calculate what percentage of that is gross profit (gross profit is the profit figure before you deduct all the stuff like overheads, marketing costs, salaries etc)

Think of the gross margin as the amount of (gross) profit included in revenue.

So if you sell a teapot for $20 and you know the gross margin is 50% then your gross profit is 50% of $20, which is $10. Likewise if you sell a teapot for $15 and you know your gross profit margin is 1/3^rd then you know your gross profit is $5.

If you like formulas, the formula to calculate the gross margin percentage is this:

(Selling price - cost price)/selling price

Spot the difference

Can you see that how different the percentages are for a mark-up and a gross margin.

A teapot that is marked up 100% will have a 50% gross margin.

A teapot that is marked up 50% will have a 1/3^rd gross margin

And that is why it is so important to get it right.

Not surprisingly business owners get confused but in doing so they can misunderstand their business, and make shocking decisions. The most common mistake is see is people thinking that if they have marked something up by 50% that 50% of their revenue is profit, but it’s not. It’s just 33.3%. Quite a difference.

More on this is the next post.