Margins vs. Markups: What You Need to Know
Starting a food business comes with many variables and moving parts. Will consumers want the products? Do they like the packaging? Is the pricing right? One thing that shouldn’t be variable is understanding what someone means when they use the terms markup and margins. In this guide, we break down margins and markups, how to calculate each, and the difference between the two.
Margins vs Markups
First things first, what exactly is the difference between margins and markups? Margins, also known as gross margins, is the percentage difference between the sale price and the cost of making the product, or the percentage of how much the product sells for above the actual cost of the product itself.
A markup, meanwhile, shows how much more your selling price is than the amount the item costs you. In a nutshell, it’s different math describing different results.
When to Use Margins vs Markups
In packaged food, you want to focus on your margins. Retailers and distributors operate based on expected margins. It will also help you understand if your pricing and variable costs are structured in a way where your business can be successful. A low margin means your product is either priced to low or your variable costs are too high.
How to calculate margins
Let’s say, you sell cupcakes for $4 each. The ingredients, labor, and packaging costs you $1.50. First, find your gross profit, or the difference between the revenue ($4) and the cost ($1.50).
$4 – $1.50 = $2.50 gross profit
To find the margin, divide gross profit by the revenue.
$2.50 / $4 = 0.63 margin
To make the margin a percentage, multiply the result by 100.
0.63 X 100 = 63% margin
The margin is 63%. That means you keep 63% of your total revenue. You spent the other 37% of your revenue on purchasing all of the delicious ingredients and beautiful packaging for your cupcakes!
How to calculate markups
Similarly to a margin, you first find your gross profit by subtracting COGS from revenue. Here is an example:
Using the same cupcakes example from above, you sell each cupcake for $4. The COGS are $1.50. First, find the gross profit.
$4 – $1.50 = $2.50 gross profit
To write the markup as a percentage, divide the gross profit by the COGS.
$2.50 / $1.50 = 1.67 markup
To make the markup a percentage, multiply the result by 100.
1.67 X 100 = 167% markup
The markup is 167%. That means you sold the cupcake for 167% more than the amount you paid for it.
Converting Between the Two
Sometimes it’s necessary to convert the markup to a margin or vice versa. Luckily, the math is not too difficult.
To find the margin from a markup, use this formula:
Margin = [Markup / (1+ Markup)] X 100
To find the markup from the margin, use this formula:
Markup = [Margin / (1 – Margin)] X 100
We recommend practicing a few conversion practice problems to really get a firm grip on the concept.
The Importance of Knowing the Difference
Knowing the difference between a markup and a margin can help you set goals tailored to your business. It also makes clear what someone means when they use one term or the other. You do not want to get stuck thinking you are making a certain amount when in fact you are making something else entirely.
If you know how much profit you make, you can set your prices based on the margin and markup formulas above. This could very well be the difference between your business being in the black vs the red.