If you own a retail business, you need to be on top of all the numbers regarding your business. This includes knowing how to calculate markup and margin for retail stores. There are simple formulas you can use to calculate both markup and margin.
To calculate markup the formula is (Price - Cost)/Cost. As for the margin, the formula then is (Price - Cost)/Price. Using these formulas, you can easily calculate margin and markup for your business.
That is not all there is to it though. To know more about these in detail, keep on reading. I will go in-depth in explaining what are margins and markups, how they differ and which one should you be using and when.
What are Margins and Markups?
Business owners need to have everything about their business basically at the top of their heads. You need to be able to know what your costs are and also how much you should be selling your products for to make a profit.
If you have a target profit, you also need to be using these formulas to come up with an appropriate selling price. Many people get confused between markup and margin. So, I decided to break it down once and for all.
In essence, your markup is how much more you decide to sell a product compared to its buying price. In this case, the more your retail price is the more the markup. Of course, you will be selling your products at a markup. That is basic business. That is how you would earn a profit.
Another way you can put it is the difference between the price you sell a product at and the price you paid to buy it. Markup shows you what percentage your cost is from the profit you made. Markup is always presented as a percentage of the cost.
What is margin then? Margin is what percentage of the sale price is your profit. Margin is also presented as a percentage value but the sale price is the main concern here. Markup and margin are related in the sense they are derived from the same set of numbers.
But in reality, they are quite different. Now that you know what is markup and margin, let’s get on with how to calculate markup and margin for retail stores.
How to Calculate Markup and Margin
Knowing how to calculate your markup and margin is crucial. Especially in the retail business where you are already dealing with low-profit margins. I will break down the calculation process as much as I can by using placeholder numbers to make it easier to understand.
How to Calculate Markup
Before I dive into the calculation of markup, let's assume two things. Say the cost of me purchasing a product is $2. I then sell that product in my store for a price of $4. That $4 is my retail price. We will use these two sets of numbers to calculate the markup and margin.
So, for example, if something costs you $2 to buy and your retail price is $4, your markup on that is 100%. Always remember that markup is calculated based on the cost. Here is the formula:
Markup = (Price-Cost)/Cost
To break it down even further, let’s put the numbers in the formula:
(4-2)/2 = 1 (which is a 100% markup)
How to Calculate Margin
We will calculate the margin in the same process too. Since markup shows you what percentage of the sale price is your profit, this time you will divide with the sale price. Here is the formula:
Margin = (Price-Cost)/Price
Again, to go back to the previous example of buying a product at $2 and selling it at $4. Put the numbers in the formula. (4-2)/4 gives you 0.5. Here is the thing, markup is also shown as a percentage. So, 0.5*100 you get 50%. Your margin is 50%. That means 50% of the $4 sale price is your profit.
There is something to note here. Not all retailers have a 50% margin. That is indeed quite rare. We kept things simple just for explaining the concepts.
The margin will not be proportional to the markup either. As you can see from the example even though the markup is 100%, the margin is 50%.
Defining the Terms
Let me define some key terms that will help you get a better grasp of the whole thing. These key terms will be used throughout the lifetime of your business and knowing these if of course a good idea.
Revenue – Revenue is simply the sum of all the products you have sold and the money earned from that. Nothing has been deducted from this amount.
Gross Profit – Gross profit is the amount you have left after you have deducted the cost of goods sold from the revenue you generated. That means, fixed expenses like rent, electricity bills and other expenses have not been taken into account. You calculate the gross profit by subtracting your COGS from your revenue.
Cost of Goods Sold (COGS) – What is COGS then? The cost of goods sold (COGS) is the cost that you incurred when selling the products. All your expenses that are incurred for actually selling will come under COGS. A key point to note here is when calculating the cost of goods sold, only the variable cost will be counted.
That means the costs that are affected if you sell more. Things like the cost of raw material, labor, packaging, etc. Fixed costs like rent and other bills are not taken into account when calculating the cost of goods sold.
Net Profit – Net profit is the amount of money or profit you are left with when you deduct all the expenses from your gross profit. That means net profit is gross profit minus cost of goods sold and all the other expenses like fixed costs, depreciation and others.
Using Markup and Margin for Pricing Your Products
When you run a retail store, pricing is very important. You want to be competitive in the market. But you also do not want to charge so low that you make a loss. That is why it is better to know when you should be using markup and when you should be using margin. In some cases, it is better to use markup and in other cases, it is better to use margin.
Using Markup to Determine the Retail Price
If you want to use markup to determine the selling price, you must make sure you have all the information about your business clearly understood. You need to know what your operating costs are.
Everything from rent, salaries, discounts comes under the operating cost. After you have all that down, you can set a target markup to sell your products. So, all you have to do is to know all the costs applicable in you selling the product.
Then multiply it with the markup percentage to land on the selling price of your products. However, there are some things you need to consider when deciding to price based on markup.
Things to Consider for Markup:
- Most industries have a standard markup
You will notice that some if not most industries have a standard markup. Everyone operating in that industry will markup a product within that standard. This, in turn, creates an even ground for all the companies in the industry.
You do not want your markup to be above the standard in this case. That will cause you to lose your competitive edge. Unless you offer a unique value and have built that brand loyalty, it is best to be within the industry-standard markup. That is true for most cases.
- Markup Based on Product Category
Just because you have decided to use a markup pricing strategy does not really mean that you should apply the same markup percentage to all the products you sell. As a retailer, chances are you are selling multiple products from different categories.
It would be wise to have different markups for the products based on the category and also the turnover. For example, a product that has a high turnover, like it basically flies off the shelves, can have a lower markup. On the flip side of the coin, products with a lower turnover can have a higher markup.
Using Margin to Determine the Retail Price
Pricing your products based on margin is always a good idea as markup pricing can sometimes give you inflated numbers. Especially with a markup accounting system, you might think your business is making more profit than it actually is.
By using margin as a pricing tool, you can be sure that a certain percentage of the selling price is above the cost of goods sold. Also, the same applies here in terms of standard. Whatever margin you decide to set the price you need to ensure that the customers are willing to pay that amount as well.
Things to Consider for Margins:
- Include Other Expenses as Well
When you are targeting a profit margin and want to set a selling price based on a profit margin, it is always a good idea to take into consideration the other expenses rather than only the cost of goods sold. Things like rent, electricity bills and other overheads need to be considered.
- Margin Pricing is Best for Accounting as Well
Pricing based on margin is also good for accounting. It gives you an accurate representation of how your business is doing. Unlike markup, the numbers are not misrepresented. Since margin clearly shows you how much profit a product is making, it is more accurate and gives you a clearer and more in-depth understanding of it all.
How to Increase Profitability
Profitability is how well a company can use its resources to generate revenue as compared to the cost. So, you would want to increase your profitability as much you can.
This will lead you to have more profits and healthier financial records at the end of the year. Here are some short and effective ways to increase profitability.
- Streamline the process – If you streamline your operating process you can save money in the long run. This is great as fewer bottlenecks will be in the system.
- Create a brand – A strong brand will garner customer loyalty that will make your profits increase by repeat purchases from the loyal brand advocates.
- Increase per-customer spending – There are a lot of retail tactics you can use to make sure customers spend more. This may be by upselling them or offering a complimentary product along with their purchase.
Now that you know how to calculate markup and margin for retail stores, you can use this knowledge to increase your profits and charge the right price for your products. Retail business can be hard and quite competitive. But with the right business and pricing strategy in place you can overcome those easily.