Accounting terminology is not the most exciting topic in the world. And I am sure that in some cases accountants use it just to confuse people and to make themselves indispensable. Two words that I think people often get confused about are markup and margin. For a long time I thought it didn’t really matter what terminology you used as long as you understood how you were calculating your prices.
But if you are growing and starting to negotiate with large customers then they may ask you questions like what your markup or margin is to see if they are going to be able to make a deal with you. You are also likely to get similar questions if you are seeking funding from the bank or private investors. They will want to know what you are making on your product. So it is in your interests to know what you are talking about.
I think it is easiest to explain the difference with an example:
I have a bottle of my super sauce that I sell for $10 and it costs me $6 to make.
The margin on this is $4 ($10 less the $6). If you put this in percentages it is $4 divided by $10 and multiplied by 100 getting you a margin of 40%
Markup in dollar terms is normally expressed in the same way as the margin – $4 but as a percentage it is $4 divided by $6 multiplied by 100 getting you a markup of 66.67%.
Quite a big difference in the percentage. Imagine if you agreed to sell to a retailer with a markup of 40% thinking margin and markup were the same thing. You would be expecting the $10 but what you would actually get would be $8.40 ($6 multiplied by 1.4). While $1.60 may not be a big deal for one item if you are selling 1,000s of units or even 100s it starts to add up. And the bank may look at you quite differently if you are trying to borrow money. This is especially so if the bank is used to seeing markups of 66.67% in your part of the food industry. They may think you are selling too cheaply and aren’t going to last.
Hate maths? Then this calculator is a handy tool for working out the markup and margin.
I hope you are now feeling like you are on top of the difference between margin and markup and would be comfortable talking to customers and funders. Knowledge is power and being able to talk accountant will certainly go a long way to helping you manage your business. To help you gain that knowledge I am setting up a challenge in Instagram and Facebook. Each week I’ll post one accounting word. Challenge yourself to understand that one word and in a few months you will find yourself speaking accounting with the best of them. Follow me on Facebook or Instagram to join the challenge.