Mark-ups and margins confusion

So you sell products or services or a combination of both and you add a mark-up on your costs when you quote. Sounds pretty easy, doesn't it. But its confusing because adding 20% to costs and being happy with a 20% profit are very different. This is what I mean:

You buy a product for $100 and you add a 50% mark-up on it and sell it for $150. You therefore make a $50 profit on the product which is actually a 33% margin. Here is the maths:

Cost $100 + $50 (50% markup) = $150 sales price

Gross profit or margin = $50 ($150 sale price less $100 cost)

Margin % = 33% ($50 margin divided by $150 sales price)

Markup = Cost x markup %

Margin = Sales Price - Costs

Margin % = Margin / Sales Price 

What's the problem?

Well its all in the assumptions made. Many business owners get confused and assume that their mark-up % will equal their gross profit (or margin %) and then wonder why they don't make any money.

For example, a business owner may decide that she need to make 20% gross profit on the products she sells in order for her business to make enough money to pay her staff and overheads. So she adds a 20% markup on her products. In actual fact, she will only end up with a 16.67% gross profit margin.

When you provide a fixed quote and the costs blowout in the delivery, the margin ends up being eaten up and you end up with even less gross profit which many not even cover your overheads!

Gross Profit must be greater than your overheads

Make sure you know exactly what your gross profit and the margin is otherwise how do you know whether the business will make a profit . You could be wasting your time running a business that makes no money!

The Markup is always a larger number than the Margin

As a general rule - you should aim to achieve at least a 10% margin so that you have enough profit to pay your overheads.

Only very large companies can make a profit having a margin less than 10%.