Mark-ups & Margins

A mark-up is often referred to as cost-plus pricing, mark-up pricing or full-cost pricing. There are several rules-of-thumb related to mark-up pricing. For example, businesses whom sell to consumers may typically expect to price items at 20 to 100% above their cost.

To determine a product's selling price using the mark-up method, the total cost of producing a product on a per unit basis must be known. Total cost should include all of the costs incurred in getting the product to the point of sale. This would include but is not limited to input costs, labor, overhead costs, transportation costs, warehousing costs, distribution costs and marketing costs.

The formula for determining a product's selling price using a desired mark-up percent is:

Selling Price = Total Cost x (1 + Mark-Up Percent)

Selling Price = $2.00 x (1 + 0.27)

Selling Price = $2.00 x (1.27)

Selling Price = $2.54

Therefore, if you want a mark-up of 27% (a profit equal to 27% of total cost) the selling price must be set at $2.54. Mark-up percent is the proportion of total cost represented by profit.

These numbers can be used to determine the mark-up percent. In this scenario, the formula for the mark-up percent is:

Mark-up Percent = (Selling Price - Total Cost) ÷Total Cost

Mark-up Percent = ($2.54 - $2.00) ÷ $2.00

Mark-up Percent = $0.54 ÷ $2.00

Mark-up Percent = 27%

The notion of mark-up pricing should not be confused with profit margins and gross margins. The profit margin is the dollar value difference in the selling price and total cost. Therefore, the profit margin in the previous example is ($2.54 - $2.00) $0.54 per unit. While the gross margin is usually thought of as revenue minus the cost of goods sold, the gross margin percent is the percent of the selling price accounted for by the profit margin. Gross margin percent is calculated as the profit margin (difference in the selling price of $2.54 and the total cost of $2.00) divided by the selling price. The formula for gross margin percent is:

Gross Margin Percent = (Selling Price - Total Cost) ÷ Selling Price

Gross Margin Percent = ($2.54 - $2.00) ÷ $2.54

Gross Margin Percent = $0.54 ÷ $2.54

Gross Margin Percent = 21%

If a desired level of gross margin is known, the formula for gross margin can be modified to calculate the selling price. Using a desired gross margin percent, the formula for calculating the selling price is:

Selling Price = Total Cost ÷ (1 - Gross Margin)

Selling Price = $2.00 ÷ (1 - .21)

Selling Price = $2.00 ÷ $0.79

Selling Price = $2.54

It is clear that the gross margin of 21% is different than the mark-up calculated earlier (27%), although both examples used a selling price of $2.54 and a total cost of $2.00. Mark-up and gross margins are often used in calculating and evaluating selling prices. However, they should not be used interchangeably for they are defined and calculated differently.

Summary

• Mark-up Percent is the percent of Total Cost that is Profit

• Gross Margin Percent is the percent of the Selling Price that is Profit

• Profit Margin is the difference in Selling Price and Total Cost