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Home » Accounting

Mark-Up Or Margin, Are You Confused?

Calculating Profit Margins

Knowing How to Calculate Profit margins is Important if You Want to Know if a Product is Profitable.

Perhaps the most shocking is the fact that the commonest type of search which finds my site goes something like “What markup do I need for a 25% margin?”

“Why”, you ask, “do you find that shocking?” The answer simply put is that it shocks me that business owners are struggling with the concept of margin when it is the basis of almost all business analysis, and if they don’t understand it, they are putting their business at serious risk. To understand why let me give you a real life example.

I worked with an HVAC contractor in the mid west and early in our relationship he showed me his financials prepared by his CPA. This CPA had done a great job of presentation and had carefully separated variable and fixed costs, and the contractor showed me that his fixed costs were running at a smidgin over 25% of sales. “I use a minimum markup factor of 1.3 or 30%, so why don’t I make a profit?”

If you don’t already see his error, you must read on because this is very important!

“You got the first part right,” I said, “If your fixed costs are at 25% of sales, your margin must be greater than 25% for you to make a profit. Unfortunately, a markup of 30% is a margin of only 23.08%, so at that markup you must lose money.” And, yes, he was losing money!

It took us only a few days to correct the problem, put in place a proper pricing structure, and he was off on the right track. A year later his margin was nearly 27%, guaranteeing a profit, but with improvements in processes which cut his fixed costs to 21% he ended up with a net 6.0% on the bottom line.

For the more mathematical reader it is simple to see how this works from the formula:

Gross Margin % = Markup % / Markup Factor.

This clearly shows that gross margin percent must always be less than the markup %, and is more so at higher markups.

That client will never regret the decision to get some management training, and his bottom line will be enhanced as a result. It is a smart thing to do to acquire the knowledge you need to be successful. 

Michael Anderson

Meet the Author Michael Anderson

Michael Anderson has written 25 Articles on Small Business Delivered.

With 45 years of experience in leading positions in business across North America and internationally, Mike Anderson knows the business of business. More important, he has learned how to teach it. He is now consulting to small and medium sized companies, specializing in CEO and senior management training. Please Visit www.trainmetobeceo.com

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