Pricing work is crucial to a profitable trades business. There are many ways to price correctly including using past quoted work, tenders, charge-up (time and materials), or even having a set price book. Whichever pricing method is used, one thing is always necessary–understanding your gross markup and margin percentages to ensure the profitability of jobs. If you don't have these numbers on hand, or don't know the difference between the two, jobs may be underpriced and your business could lose valuable money. Once you’ve got an understanding of your pricing strategy, achieving better results and preparing for different profit margins will be a hell of a lot easier.
The Difference Between Markup and Gross Margin
Markup and gross margin are commonly confused in the business world, so if you’ve been muddling up the two for a while don’t be too hard on yourself. Especially, if like me, numbers are NOT your forte. Let's get through this together.
Gross margin is total revenue after taking into account business costs related to the goods you sold your customer, also known as COGS (cost of goods sold). It shows the percentage profit before deductions. The markup margin also considers COGS and revenue, but in a slightly different way. Once calculated, it shows the percentage amount between an item’s cost and price to achieve the selling price.Utilizingboth markup and gross profit margin percentages are crucial when pricing your services. This is because a markup directly impacts gross profit margin. For example, a 30% markup on a product or service will give you a 23% gross margin, a 43% markup will give you a 30% gross margin and 100% markup gives you a 50% gross margin. Fun fact, the markup percentage will always be more than the gross profit margin. Take a look at the chart below to see the relationship between markup and gross profit margin.
Which profit margin should you aim for?
Now that you’ve established the difference between markup and margin, it’s time to set a goal for an average profit margin to aim for. This number will be different for every business. On average it ranges from as little as 5% to as high as 20%, but there are lots of different factors to consider. The size, age and location of the business are all good things to bear in mind. For example, a new business may aim for a higher profit margin because it will generally have fewer sales and people on the payroll and therefore have lower overhead costs. However, as time goes by and the business grows, these margins will shrink.
In contrast, business types such as consulting firms, software-as-a-service (SaaS), pharmaceutical and financial services will most likely have a higher profit margin. This is because they don’t have to account for things such as stock, there are fewer operating costs and the startup costs are drastically reduced.
How Do You Calculate Margin and Markup?
To calculate markup you’ll need to consider the cost of purchasing to your business, as well as the price customers will pay. For example, purchasing screws from the supplier will cost $0.50 per screw, but customers will pay $1.00. This gives you a markup of $0.50 with a markup percentage of 100%. Why 100%? Because you are making a profit of $0.50 per screw which is 100% of the item’s original cost.
Your percentage margin for the same example would be 50% because you will make a $0.50 profit. Remember these rules regarding markup and gross margin and you’ll be on the right track to improving profitability.
What is the markup formula?
Let’s take a look at these formulas in more detail.
Before tackling this formula, first calculate the cost of sales and gross profit.
Cost of sales refers to the cost of a job or project at its completion. This includes the labor, materials and any other job specific costs such as subcontractors or equipment hire. For example, the cost of sales for a bathroom alteration could be $10,000.
Next, the gross profit. To calculate this, you need to subtract the cost of sales (using the example above, this would be $10,000) from the sale price. Now, let’s assume that the sale price for a bathroom alteration is $13,000. Therefore, the gross profit would be $13,000-$10,000 = $3,000.
Finally, to calculate the markup divide the gross profit by cost of sales and multiply by 100, which would be:
Markup = ($3,000/$10,000) x 100
Markup = 30%
What is the gross margin formula?
So now you’re probably wondering where does your margin come from, right? If you can stay with me, there’s a formula for that too which will help:
If we use our previous figures as an example, the equation would be:
($3,000/$13,000) x 100 = 23% profit margin
Therefore, for this bathroom renovation, you would have a markup of 30% and a gross margin of 23%.
Reducing Margin Vs Markup Mistakes
Now you’ve got your head around the difference between margin and markup, make sure the information is used effectively to ensure profitability and growth within your business.
Implement a pricing tool to quote sales
When shopping around, one of the first things I look for is affordability. Being able to clearly see an item’s cost, whether that be the installation of a new bathroom or just a new toilet brush, I want the transparency of knowing what the costs are. And I’m not alone. This is information all customers want to know up front. With a field service management software solution you can provide quotes to the field customers detailing all of the costs involved for a project, no matter how large or small.
Educate your sales team
There are a lot of moving parts to any business and making sure each department is informed is the key to success. When it comes to the cost of services or goods, the sales team needs to know the right details to tell customers. With a large portion of revenue being brought in from your sales team, it’s important to make them aware of the difference between markup and margin percentages. In addition, ensure they have the heads up on when any promotional offers, price increases or changes occur.
That’s the brain numbing number crunching out of the way, now it’s time to put it into practice. Need more guidance? Our blog Ready, Set, Scale: How to Grow Your Field Service Business is also full of helpful tips around sales, marketing and operations.