When pricing your services and products it is important that you do so in order to make a profit.
Most businesses will look at either mark up or margin to come up with their prices but not everyone understands how they work, and worse still some even confuse the two.
Both are accounting measurements that use the same input information, but they analyse it in different ways to give different information for business owners to use.
Profit margin refers to the amount of profit you have made on a sale after the cost have been subtracted, and is usually expressed as a percentage. When you have your profit figure you divide this amount by the sale price.
So for example, you purchased a stock item for £200 and sold it for £300, meaning a profit of £100. Take the £100, and divide by the £300 sale amount. Expressed as a percentage you have a gross profit margin of 33%, meaning that approximately a third of your revenue is gross profit.
However, if you then bought the same item for £250 and still sold it at £300, you would have a profit of £50, meaning your margin has reduced to 16%.
Mark up refers to the amount by which the goods are priced over and above their original cost price, basically the selling price minus the cost price, again expressed as a percentage.
Using the figures above, the first transaction would have a mark up of 50% (£300-£200/200). Using the second set of numbers with the increased cost of £250 gives a mark up of 20% so you can see how these results can vary and how applying the wrong percentages to your pricing could be disastrous.
If you sold a thousand units at those two prices it would the difference between a gross profit of £100,000 and £50,000 respectively which is why it is so important to understand margin and mark up, and how they effect profit.
It is also important to remember that the margin here is for gross profit – meaning it takes account of all the direct costs of the transaction such as original cost price, shipping, direct labour, etc. When pricing your products you will also need to consider all the other indirect costs a business has – insurance, rent, travel, wages, pensions, stationery, etc. There is no point being in business if you can’t cover all your costs and not make a profit on top.