It takes more than innovation and guts to win a business. You also need to do some math, particularly accounting. It might not be something that appeals to you, but it is vital for your survival. Without it, you won’t even know if you’re earning or bleeding money.
Of course, you can always hire an accountant to help you. You can also use tools such as price tracking to know if your price is competitive. Still, nothing beats even having basic knowledge.
You can begin with one of the most confusing terms for newbie business owners: margin vs. markup. What’s the difference between these two?
What Is a Markup?
A markup is a percentage or a fixed amount you add to the cost of your goods to derive your price. The purpose is to ensure you can generate a profit or revenue from your products.
Most businesses use the percentage to calculate the markup price. Usually, it can be between 10% and 100%. Sometimes it’s even more, which explains why some can markdown or sell their goods at an impressive discount.
If you want to know the best markup price for your products, you can follow a simple formula:
- Determine the cost of your product.
- Divide it with one less the markup percentage.
Let’s say that you have a mug that costs you $5 to produce. If your markup is 20%, then your sales price is $6. While you can price your product at any amount, know that consumers are sensitive to price. They might have a certain threshold, which, when crossed, means they won’t buy your goods.
What Is a Margin?
Also known as profit margin, it is the difference between your expenses and sales revenue. It falls into two categories:
- Gross profit margin
- Net profit margin
In the gross profit margin, you reduce your revenue with the cost of goods sold. Also called CGS, it refers to the expenses you incur for producing something. Many factors can affect your total cost of goods sold. These include:
- Raw materials
- Shipping or freight
- Discounts and product returns
With the difference, you deduct all the other expenses not included in CGS. These might be:
- Amortization and depreciation
- Marketing or promotions
As a business owner, you want to know if your entire operations are doing well. One of the indicators is the margin percentage.
If you want to get it, you have to divide the gross profit with your revenues. For example, if you earned $100,000 and your cost of goods sold is $25,000, then your gross profit is $75,000. The total margin percentage, meanwhile, is 75%.
Like your markup, your profit margin can be as low as 5% and as high as 50%. The higher it is, the better. It seems both are entirely different things—and they are—but they are interrelated. Your sales revenue relies heavily on the price of the product. You cannot come up with a sales price if you don’t include a markup.
As your business grows, accounting can be more confusing, overwhelming, time-consuming, and complicated. Learning the basics of the most common concepts, though, will ensure you can understand reports and even make ideal financial decisions.