As you build your business, one of the most important questions you’ll ask yourself is “How do I decide what to charge for my product?”
Before you answer, you should understand two important terms: margin and markup. You may have heard the words used interchangeably, but they are not the same. In fact, if you don’t understand the difference, your bottom line can suffer dramatically.
Let’s take a closer look, starting with your gross profit—the difference between your sales price and your cost. Margin and markup are two different ways of expressing your gross profit: mark-up is how much you add to your cost to arrive at a selling price. Margin is what’s left over from the sale after accounting for the cost.
In dollars, these numbers are the same. But expressed in percentages—as they are in most financial reports—they can be very different.
Here is how markup and margin percentages are calculated:
Gross Profit /Cost=Markup Percentage
Gross Profit/Selling Price=Margin Percentage
These numbers illustrate the difference:
Say your cost is $100 and your price is $130, for a gross profit of $30. Your markup percentage is 30/100, or 30 percent.
However, your margin percentage is 30/130, or 23.1 percent.
If you run the numbers we’ve been using in this example, you’ll see that you’d need to charge about $143 to get a 30-percent margin. This shows how mistaking your markup for your margin could do serious damage to your bottom line.
Best Practice Tip
So how do you decide what to charge? First, do some calculating of your own. Figure out your business’s overhead expenses and your production costs.
Then do what the experts recommend: Decide what you want your margin percentage to be. Then determine the selling price using this simple calculator:
Still have questions? Northern Initiatives can help.