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Laurie Owen: Don’t Confuse Markup and Profit Margin

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It’s all too easy to arrive at an incorrect selling price when you confuse the two terms.

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[h3]Don’t Confuse Markup and Profit Margin[/h3]

[dropcap cap=T]here are many jewelers who believe markup and margin are the same thing — and sometimes they are. But generally they’re not. The issue is how to arrive at a target selling price when you know the cost. The important concern here is the amount of gross profit dollars contributed from sales to cover general overhead.[/dropcap]

Here’s a simple example to illustrate the point:

Item selling price: $ 1.50
Item cost: $ 1.00

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Does this price-cost relationship represent 50-percent markup or 33-percent markup?

Regardless of your answer, we can safely say that this example represents a gross profit margin of 33 percent.

The real question is: What markup does this represent? Or, stated another way, how much do you have to mark up a product over cost to produce a 33.3 percent gross profit margin? The answer here depends on how you define markup.

Here are the two possible definitions:

Definition A (the common definition):
Mark-Up = Selling Price – Cost
Cost = 1.50 – 1.00 = 50%
1.00

Definition B (as defined by retailers):
Markup = Selling Price – Cost
Selling Price = 1.50 – 1.00 = 33.3%
1.50

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It’s important to note that either definition of markup leads to a 33.3-percent gross profit margin. Using the more conventional definition, it requires a 50-percent markup to produce a 33.3-percent gross profit margin, but retailers would say it requires a 33.3-percent markup. In other words, markup and margin are the same thing when using the retail definition.

We believe that confusion — and errors! — arise when you hear someone say the markup and the margin are the same (Definition B), then conclude that you simply multiply the cost by the markup (Definition A) to get the margin.

 


 

Laurie Owen is senior vice president at Business Resource Services. Contact her at [email protected].

[span class=note]This story is from the November 2008 edition of INSTORE[/span]

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