Formulas & LessonsSeptember 10, 20262 min read

Markup vs margin: the mix-up that costs shops money

Two people in the same shop agree to 'make 40 percent on everything.' One means margin. The other means markup. For months they price differently, and nobody notices until the books are done and the profit is a good deal smaller than someone expected.

Markup and margin are two ways of describing the same gap between cost and price. They use different denominators, and that makes all the difference.

The two formulas

Same item, two percentages

Markup

Formula: (price - cost) / cost
Cost $60, price $100
($100 - $60) / $60 = 66.7%
Starts from what you paid

Margin

Formula: (price - cost) / price
Cost $60, price $100
($100 - $60) / $100 = 40%
Starts from what you charge

The profit is $40 either way. Only the way of expressing it changes.

Markup is profit as a share of cost. Margin is profit as a share of price. A markup is always a bigger number than the margin on the same sale, so a '40 percent' that means markup brings in less than a '40 percent' that means margin.

The trap

Pricing for a 40 percent margin, as an example

Cost is $60.

Add a 40 percent markup: $60 x 1.40 = $84.

Margin on that sale: ($84 - $60) / $84 = 28.6%.

To get a real 40 percent margin: price = $60 / (1 - 0.40) = $100.

A shop that adds 40 percent to cost and thinks it earns a 40 percent margin is short by more than a quarter of what it planned. On a year of sales, that gap is a lot of money.

Same $60 item, two prices

Add 40% markup: price $8428.6% margin
Price for a 40% margin: $10040% margin

Converting between them

Price for a target margin = cost / (1 - margin). For 40 percent: cost / 0.60.
Price for a target markup = cost x (1 + markup). For 40 percent: cost x 1.40.
Markup from margin = margin / (1 - margin). For 40 percent: 0.40 / 0.60 = 66.7%.
Margin from markup = markup / (1 + markup). For 40 percent: 0.40 / 1.40 = 28.6%.

What it saves you

Prices that actually deliver the profit you planned.
A fair comparison between products, since margin does not depend on how cheap the item is.
Clear conversations with suppliers and customers about discounts: a 10 percent discount on a 25 percent margin item takes a big bite of profit.

It also connects to landed cost. If your cost is wrong, even the right formula gives the wrong price.