In this article, you will learn:
The prices of your retail products directly impact your sales as well as profit generating ability of each of the retail items. Unreasonably high markups may showcase large profits in writing. However, it may not result in any money till the time you sell such retail items.
Likewise, retail items with unreasonably low markups may no doubt sell in the market. But, these items may result in lower profits for your business entity.
As a business owner, you often get confused between the terms Profit Margin and Markup. However, they are two separate accounting terms revealing different details about the retail items in question.
Thus, it is important for you to understand how Markup is different from Profit Margin. Also,you need to adopt the correct pricing strategy for your retail items. This is so because you are able to achieve the target set for your profits.
Markup Pricing is one of the retail pricing strategies that you can use to determine the correct price for your retail items.
In this article, you will learn what is markup percentage, markup formula, and how to find markup price.
What is Markup Percentage?
Markup is nothing but the difference between the cost of your retail product and its selling price. In other words, markup reveals the amount you have charged over and above the cost of your product. This is done to determine the selling price of your retail product.
Accordingly, Markup Percentage is the difference between the selling price and the cost of your product as a percentage of cost.
Thus, the more the average markup, more is the selling price of your product and higher is your sales revenue. So, markup is expressed as a percentage above the cost price of your product. The Markup Percentage is the profit that you are able to earn related to the cost of the product or service that you sell.
You come across the terms markup and margin when you are deciding the pricing strategy or preparing projected financial statements.
Thus, the prices of your products should be set keeping in mind a number of important factors. This is irrespective of what the size of your business is? For instance, the price should be such that it covers both the fixed and the variable cost. Furthermore, such a price must generate profits.
In addition to this, the price of your products should be competitive. That is, neither too high nor too low as against your competition.
Finally, it should be a price that your customers are willing to pay. Thus, the amount of average markup that you charge is a critical factor. This is because it decides how much profit you can earn by selling every unit of your product.
Also, unreasonable average markups can result in loss of sales for your business. Similarly, lower markups can severely impact your bottom line.
Markup Percentage Formula
As mentioned above, average markup percentage is the amount you charge over and above the cost of your product as a percentage of the cost price.
Accordingly, the following is the markup formula:
Markup Percentage = [(Selling Price – Cost Price)/Cost Price] * 100 = [Gross Profit/Cost Price] * 100
How To Calculate Markup Percentage?
Let’s consider an example to understand how to calculate average retail markup percentage using markup percentage formula.
A pen manufacturer sells you as a retailer a box of pens at the rate of $1.50 per pen.
Thus, $1.50 is the cost price of each pen for you as a retailer. Now, you add 50 cents to this cost price as your value. Further, you sell each pen to the final customer at the rate of $2.
- 50 cents is the average Markup amount
- $1.50 is your Cost Price
- $2 is your Selling Price
Accordingly, as per the markup calculation formula,
Average Markup Percentage = [(Selling Price – Cost Price)/Cost Price]*100
The following are the steps for you to understand how to figure out markup percentage:
- You need to determine the Cost Price of your Product or Service. In the example above, the Cost Price is $1.50.
- Next, you need to find out the difference between the Selling Price and the Cost Price of your product. In our example, this turns out to be $0.50.
- Now, you need to divide the difference between the Selling and Cost Price by Cost Price of your product. This turns out to be $0.50 in our example.
- Finally, you need to express the average markup in percentage. In our example, this turns out to be [($2 – $1.50)/$1.50] * 100 = [$0.50/$1.50] * 100 = 33.33%.
Markup Based On Selling Price
Markup based on selling price is called margin of profit or simply margin. Margin is nothing but the difference between sales and cost of goods sold. That is, it is the amount of revenue you receive after deducting the cost of goods sold from sales.
Therefore, it is important to understand terms like sales revenue, cost of goods sold, and gross profit in order to understand Markup based on selling price.
Sales Revenue is nothing but the money you earn through selling goods and services. Whereas, cost of goods sold means the cost or the expenses incurred in manufacturing those products or services.
Lastly, Gross Profit refers to the amount remaining after deducting the cost of providing goods or rendering services.
Accordingly, Markup based on selling price is expressed as a percentage of sales. So you need to divide Gross Profit by Sales or Revenue in order to calculate Margin.
Thus, the following is the formula for calculating Margin based on selling price:
Margin = [(Sales – Cost of Goods Sold)/Sales] * 100 = [Gross Profit/Sales] * 100
Now, let’s understand the Markup based on selling price formula with the help of an example. Say, you sell a product for $1,000. The cost of manufacturing such a product is $600. Thus, the Margin for such a product would be $1,000 – $600 = $400. Accordingly, Margin Percentage would be ($400/1000) * 100 = 40%.
Margin Markup Calculator
Markup Calculator is a tool that helps you to calculate the desired average markup price for your product or service.
As a business entity, you would want to sell your products or services at a price which is neither too high nor too low.
Typically, your Markup Price should be such that you are able to make reasonable profits on selling the goods and services. Furthermore, you are also able to cover all the overheads.
You just need to put in the cost and the revenue figures with the percent markup calculator. It will automatically calculate the average retail markup percentage for you.
Likewise, say you have cost and markup percentage figures and you want to determine the average markup price that you should charge for your business offerings. The Markup Calculator will instantly calculate the Markup Price for your product.
Finally, you can also use the markup calculator to find the cost. All you need to do is provide the revenue and the markup percentage figures in the percent markup calculator to determine the same.
Standard Markup Pricing – Common Approach
You as a business entity commonly use Cost plus pricing strategy. Cost Plus Pricing is also known as Markup Pricing. It is a simple approach that you use to determine the selling price of your retail product.
Thus, under Cost Plus Pricing, you first determine the cost of the product that you wish to sell. Accordingly, you add direct material cost, direct labor cost, and overheads to calculate how much of such a product or a service costs to your company.
Then, you add an average markup to this total cost to derive the selling price for your product or service. Typically, most business entities use a standard markup pricing percentage specific to a particular industry.
Thus, the markup formula that you use to determine the price of your product based on Cost Plus Pricing Method is as follows:
Price = Unit Cost * (1 + Markup)
This is a simple approach that a majority of companies follow to price their products. It is because this approach simply takes into consideration the percentage markup as well as the cost of the product.
That is, the Cost Plus Pricing Approach does not take into account factors like change in demand, consumer behavior, etc. Also, the average markup percentage used is a rate that is either based on a rule of thumb or a rate typical to an industry.
Finally, the Markup Pricing Method does not take into account a lot of indirect costs associated with your product. Thus, setting the selling price solely based on a specific average markup can be considered risky. This is because this approach does not consider all the direct and indirect costs associated with your product.
Therefore, it is important to take into account both the variable indirect costs as well as variations in the product demand.
How To Do Markup?
Though, Markup Pricing is the most commonly used method. However, it can cause serious problems for your business entity.
In the Cost Plus Pricing Method, you first determine the standard costs of producing your goods and services. Thus, you determine the Standard costs by estimating the:
- Direct costs of producing the product
- Anticipated Indirect Costs, and
- Standard or the typical output level of your business entity
Accordingly, you determine the price based on standard cost per unit. Thus, you ignore any changes in the unit costs in the short-term. Also, the average markup used is a rate typical to your industry.
Such an average retail markup percentage may be dangerous. It is because it may fail to take into account all the direct and indirect costs associated with your product.
Markup Pricing Example
Let’s consider an example to understand how Markup Pricing Approach can seriously impact your bottom line. Say, you are a grocery retailer selling seasonal fruits and vegetables. You sell Broccoli at $5 per kg during winters. However, it costs you $2.50 per kg during winter season.
Therefore, you charge a markup of $2.50. So, the Markup Percentage comes down to 100% and the Margin turns out to be 50%.
Now, there would be increased demand for Broccoli during the winter season. This is because the high quality of Broccoli would induce your customers to buy the vegetable.
Thus, you would enjoy higher margins due to lower cost during the winter season. However, the cost of Broccoli would increase during off season. This is because as a retailer the costs would increase in terms of transportation, spoilage, etc.
Also, the consumer demand will fall as they would not want to buy a high cost, low quality vegetable during the off season. So this will reduce profit margins for you as a retailer during the off season.
Say, the per kg Broccoli costs $5 and you are willing to sell it at $8 per kg during off season. Accordingly, this comes to a markup percentage of 60% and a margin of 37.5%.
So as you can see, you are able to earn a Profit Margin of 50% during the peak season. Whereas, you earn a lower margin of 37.5% during off-season.
Markup and Price Elasticity of Demand
You can use an average retail Markup Percentage typical to your industry. Provided your competitors also share similar costs and average markup percentage. But, it is ideal to associate your markup percentage with price elasticity of demand. This is because you need to achieve an optimal selling price for your product when in a competitive market.
Thus, highly successful business entities vary their markup percentages due to the changing price elasticity of demand. They offer regular discounts for slow-selling items.
Likewise, you as a retailer in a highly competitive market adjust your product prices very quickly as per the demand and supply conditions. Similarly, price sensitivity also plays an important role in determining the margins you expect on your products as a business entity.
Therefore, products that are highly price-sensitive earn lower profit margins for your business. Such products include staples like salt, milk, etc. Whereas, products like Luxury Goods, Meat, etc. have a low price-sensitivity for high-income groups.
Similarly, seasonality also impacts your profit margins over the year. In addition to this, market factors like substitutability of your product also impact markup percentages and margins for your product.
For example, you would not be able to charge a higher average retail markup percentage in laundry detergents. This is because there are a number of competing brands and substitutes available for such a product.
Why is Margin Better Than Markup?
As mentioned above, Markup is the difference between the actual cost and the selling price of your product. Whereas, Profit Margin refers to the difference between the selling price and the cost of goods sold.
Now, considering the above example, let’s understand how Margin and Markup percentage impact your bottom line.
During the peak season, you are able to charge a 100% Markup for per kg Broccoli. Now, it is very important to understand the difference between Margin and Markup and how they can impact your profits while setting the prices for your products.
You often confuse margin with Markup as a business owner. Further, you have a tendency to assume that both margin and markup are the same.
So, as per the above example, your net income would be 50% less than what you had anticipated if you assumed that 100% Markup means 100% Margin.
This could mean a lot for you as a business entity. Also, it may impact your solvency position. Likewise, with Margins, you are able to anticipate the orgit generating ability of your business easily.
Whereas, Markup does not show you the correct figures of your profit. This is because it does not take into account all the direct and indirect costs associated with your product’s manufacturing.