I have always mentioned to my business friends and clients that margins run our businesses. If you do not have a healthy margin every time you sell a product or provide a service, then your business will not last very long. It is a matter of time that you closed your doors. Not if but when.
However, it has been my experience that business owners are often confused whenever I asked them if they knew the difference between margins and markups. About 60% of them answer they are the same, 25% answer they are not very sure as they leave the matter to their accountants, and the remainder 15% answer they know the difference between them.
Frankly, this results from this simple little test has been more than disappointing. It is no wonder 85% of business owners get wrong and are leaving too much money on the table every time they sell a product or provide a service.
Let me share with you a real example:
I remember asking a client’s employee to apply a 400% markup in the list price of a certain product that I was analysing. On hearing the 400% markup, she screamed, “we have never done that high a markup before. You must be mad to apply such a high markup to this product.”
I waited and allowed her to calm down then I asked, “OK, let’s increase the margin of this product by 80%.” She became more comfortable and agreed with a smile on her face.
What is the difference in terms of profit making? Nothing. A 400% markup is the SAME as 80% margin increase. The only difference is in the numbers.
Not knowing the difference between margins and markups have caused many business owners to leave too much money on the table.
Why the confusion?
Very often we are taught that making a profit is the main reason for running a business. And we would simply add what we needed to cover our costs to arrive at our recommended retail price or the list price. For example: You have figured out that you needed a 25% profit margin to stay profitable. You tell yourself that you would add 25% to the cost price of every product that you bring in to sell. This is to say then when we have a product that costs us $100/-, and knowing that we needed to make $25/- out of that product when sold, we would markup the price of the product to $125/- ($100/- + $25/-). Logically and mathematically this is sound. Nothing’s wrong with it.
However, only 15% of business owners know the error from our experience. Only this 15% know that 25% markup is equivalent to 20% profit margin. Therefore, you would actually lose 5% profit margin every time your sell the same product or provide the same service to your customers. A 5% loss in profit margin is like a 5% discount your give to your customers unknowingly. At 25% profit margin requirement, you would need a 25% sales volume increase to cover the 5% profit margin loss due to your ignorance. To increase your sales volume by 25% is a huge task for most businesses. It is no wonder business owners are getting busier and working harder with dismal profits results. It is a downward spiral that will eventually bring any business to a halt.
At our consulting projects, we use control tables to navigate our clients’ business to profitability. In this article, I will show some numbers for you to consider in your business.
If you need 20% profit margin, then your markup is 25% of costs.
If you need 30% profit margin, then your markup is 42.9% of costs.
If you need 50% profit margin, then your markup is 100% of costs.
If you need 60% profit margin, then your markup is 150% of costs.
With this, I thank you for your time in reading this article and I certainly hope it has been helpful to you.
Please feel free to email me any questions you may have at firstname.lastname@example.org.