Question: What is the difference between markup and margin?
Gary Elekes; Founder, EPC Training:
Basically, the interpretation of a financial statement is really the key consideration here, so sales minus the cost of goods sold is always going to yield a derivative which we call gross profit. The gross profit dollars are what we look at. $100 of sales minus $60 of cost of goods sold is $40 gross profit. Margin is expressed as the gross profit dollars as a relationship to sales so we always divide by sales. Sales is always the divisor as we look at percentages.
The $40 of gross profit divided by the $100 of sales gets a 40% margin. That’s basically the mathematics that occur in a financial statement and what we need to understand is that applying a markup to the cost of goods sold is a very common pricing system. We could use 1.67 as a particular multiplier or markup, which is a 67% markup or multiplier. One being the 100% times the cost a good sold gives us the actual sale price if you multiply that number 1.67 times 40, you should come up with 99.9999, which is $100.
The confusion is that some people believe that that 40% margin can be used as a substitute for the markup if you multiply that same $60 cost of goods sold times the 1.4 margin, you will not get $99 go get something like 87 or whatever it is. That will not give you the gross profit dollars that you see. The confusion that people have is that margin and the markup factor are synonymous and they are not. In the EGIA Best Practices Library, there's a table that shows that a 40% margin is a 1.67 multiplier markup.
You just have to decide what you want to be or your gross amount to be. Further, adding a layer to that question, you shouldn’t be paying attention to your margin anyway. If you've been around EGIA and heard any of these conversations, you’d know that if I could take my computer and throw it out in the ocean back here I would when it comes to margin percentage because margin percentage is practically meaningless. If I have a 50% margin on $10, I have $5. If my overhead is $1,000 a day that's not going to get the job done but I've got a great sexy margin. We don't look at margin percentages, we look at gross profit dollars.
Give me a high material, low labor job. We replaced 72 rooftop units in one day. It was about an $850,000, 30% margin job which produced about $250,000 gross profit dollars and our overhead per day is $800. It’s not really a great margin because industry experts say we need a 42% margin. No, you need gross profit dollars and I’d take that job every day, all day long. If I could just figure out how to do that, we would all be flying private jets, we’d all have houses on the Caymans, and everything would be slick. The secret sauce is to understand that markup and margin are two different animals. You don’t want to focus on margin percentage anyway, you want to create a gross profit dollar amount.
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