The Difference Between Mark Up and Gross Margin and Why Doing it Wrong is Costing you Money
Good morning! Jon here with today’s Toolbox tip and today I want to talk about difference between “Markup’ and ‘Gross Margin.’
I see lots of people doing it wrong and I’m here to say if you’re doing it wrong or calculating it incorrectly, you’re costing yourself money – you’re leaving money on the table instead of putting it in your pocket where it should be.
I’m Jon Dale. I’m from Small Fish Business Coaching. I run the Tradies Toolbox Coaching program for the owners of trades businesses who want to grow and want to be more profitable.
Now lots of tradies talk about margin.
“I add a margin, I add a 15% margin to the other trades” or “I add a 20% margin to materials and labour.”
But actually what they calculate is mark up and when you do that, you’re costing yourself money. Let me explain why.
Okay, the point of today’s video is, ‘Mark up bad, Gross Margin good’ and also the right way to calculate it. Let me show you with the aid of this excellent diagram I prepared earlier.
Calculating markup (which is what some people are calling margin)
You calculate a percentage of your costs and you add it to your costs to make a sale price.
When you calculate Gross Margin:
You take the same percentage but it’s a percentage of the total sale price which of course is more. It’s a bigger number so you get more and you make more money. The total sale price is a bit more expensive and your margin is a bit more.
A bit more money for you, more profit, and more margin in the job for you to take home. And most of your customers have happily agreed to that percentage margin so you should calculate it the way they’ve agreed – which is also happily the way that gives you more money, should you not?
Let me illustrate it by calculating some margins for the two ways. Okay, I’m going to use $8000 for costs and I’m going to use a margin percent of 20%, mostly because it made nice, easy round numbers.
Okay, calculating markup it looks like this:
- Costs of $8000 – calculating the markup of 20%.
- 20% or 0.2 times $8000 is $1600
- Add it to the 8,000
- Makes a total sale price of $9600 each, easy peasy.
Margin calculation is slightly different, bit more complicated:
(and I confess I always forget how to do it and have to look it up)
- Your sell price is equal to the costs divided by (1 minus your Gross Margin (GM))
- 1 minus the Gross Margin of 20% (which is 0.2) and so it’s 0.8
- 8000 divided by 0.8 is 10,000
(Check your calculator if you don’t believe me)
So sale price of $10,000 compared to $9600 and a margin of two thousand instead of $1600 right? The same margin percent is $400 more in your pocket.
I hope that made it simple and made it obvious. I also hope that you’re not sitting there going, “No, they’ll never pay the extra, Jon,” because they will.
That’s bollocks and I’ll tell you why:
- You’re not showing them 2 prices side-by-side and saying, “would you pay the more expensive one?” are you? You’re only showing them the $10,000 price.
- They’ve agreed that percent margin is fair and reasonable because you told them that you charge that margin.
- It’s only 400 bucks on $10,000, we’re not doubling the price or anything, it’s a very minor difference.
- And my final point – people aren’t as focused on price as you think, when they’re choosing a trade. I’m not saying that price is not important and it’s not to say they won’t try and make you be cheaper but it’s not as important a part of their buying decision as you think.
- And most people choose their trade, choose the one they trust, choose the one they like, and then make sure the price is okay. (And that’s in the commercial environment and a consumer environment)
So I hope I’ve persuaded you to use Gross Margin calculation instead of a mark up calculation every time because a markup calculation, particularly when you say margin but you calculate markup, is cheating you. You’re cheating yourself out of money.
Now my coaching is about helping people make more money, make more profits in their professional trades businesses.