Margin and Markup

So you have an item which costs 100 and you need to find the selling price which would make the company 20%. Do you use margin, or markup?

Margin and Markup are two concepts that measure value added and profit in terms of a percentage, either of the selling price, or the cost price.

For the same amount, Margin and Markup do not result in the same value.

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Let’s have a look at the equations used.

If the difference between the selling price and the cost price is the profit:

margin is calculated by dividing the profit by the selling price, and

markup is calculated by dividing the profit by the cost price.

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Let’s see it in action with some numbers.

We are usually in the situation where we want to determine the selling price based on a known cost, and a desired rate. Which method should we use?

First, let us rearrange the equations so that both show the selling price as the subject of the formulas:

If my product costs 100 and I need a margin of 20%, the selling price would be
100/0.8 = 125

On the other hand, if I were to markup by 20%, the selling price would be
100×1.2 = 120

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So when should I use which?

I guess it is a matter of policy. Such choice is usually dictated by the policies of the department, or based on your experience in the sector.

I personally prefer the margin method for the following reasons:

• Margin keeps the value adding in terms of the selling price. This keeps the profit in perspective of the selling price.
• It allows me the keep the rate numbers lower, thus more conservative. Depending on the value being added to the product, and the market in question, 10% to 20% maybe good enough for a good profit; 30% to 40% may be very healthy, while 50% and more might be very lucrative. Once again, remember that this is highly subjective.
• I also find that margin puts discounts in perspective. A 5% discount on a selling price having 20% margin still gives me around 15% margin. For the markup method, a 5% discount effectively eats up closer to 6% of the profit.

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I hope that the above helped you clarify this point. It took me a while, some modelling and simulation, and experience to understand and master this. Today I am comfortable in making quotations that generate good returns for the value offered, give me confidence in negotiating satisfactory discounts to the clients, and designing meaningful KPIs for the team.