It would surprise you how many small business owners and sales professionals get confused, or do not understand the difference, between the terms “profit margin” and “markup” which are often bandied about freely or used interchangeably.
Recently, I have been working with a small business owner and two college educated, experienced, professional sales people. We were preparing to visit a major multi-million dollar account. A couple of hours before we were ready to leave for the meeting and while going over the final presentation, one of the sales people mentioned that the account we were about to visit indicated that they need a 50% markup. This threw the small business owner and the senior sales person into a major meltdown. I immediately realized that none of them knew the difference between gross margin and markup.
The price that we developed was 35% gross margin based on the gross margin formula which is a much different result than a markup formula; (note that a 35% gross margin equals a 50% markup). I spent probably 15 minutes trying to explain the difference simply by saying that markup percentage is the percentage difference between the actual cost and the selling price, while gross margin percentage is the percentage difference between the selling price and the profit. They believed that if a product is marked up, say 25%, the result will be a 25% gross margin. However, a 25% markup rate produces a gross margin percentage of only 20%. I could see by looking into their eyes that they did not fully understand or see the difference.
In frustration I put on my teaching hat on and tried to give them an example in simple terms.
Say you bought an item for $25 and could sell it for $50, doubling your money.
In this case your markup would be the difference between selling price and cost price divided by the cost of the item and multiplied by 100 to bring it to a percentage. They were still not fully understanding.
For example: ($50 – $25) = $25(difference). $25(difference) / $25(cost) = 1 x 100 = 100% (here “/” stands for divide). The markup is 100%.
When you look at the profit margin on that sale, that would be (difference between selling price and cost price) divided by the selling price and multiplied by 100 to bring it to a percentage.
For example: ($50 – $25) = $25(difference). $25(difference) / $50(selling price) = .5 x 100 = 50%
As you can see in the examples given above, the only difference in the equations is dividing by the cost or by the selling price.
Finally they understood. If nothing else, they knew that the pricing we had developed was ok to go to the presentation.
As a gift I went out and bought them three cost-sell margin calculators and developed this chart that they can keep close to their wallet and purse.
Margin vs. Markup Chart
15% Markup = 13.0% Gross Profit
20% Markup = 16.7% Gross Profit
25% Markup = 20.0% Gross Profit
30% Markup = 23.0% Gross Profit
33.3% Markup = 25.0% Gross Profit
40% Markup = 28.6% Gross Profit
43% Markup = 30.0% Gross Profit
50% Markup = 33.0% Gross Profit
75% Markup = 42.9% Gross Profit
100% Markup = 50.0% Gross Profit
Every time I work with a new client regarding sales and their sales team. The first thing I ask is whether they know the difference between gross margin and markup. I suggest all small business owners do the same with their sales team.