A common mistake by retailers is to confuse markup and margin. This confusion can result in lower-than-expected profits. Here are some tips on how to keep them straight, and a little advice on which to use.
To start, it's important to know that "margin" is frequently referred to as "GP%" or "Gross Profit Percentage." Your vendors probably use GP% on your invoices instead of margin. I use the term "margin" here, but know that GP% and margin mean the same thing.
The mistake I see most often is a retailer calculating a markup, but thinking he or she is calculating margin. The mistake might look something like this:
An item has a $1.00 cost and the retailer wants a 30% margin. He or she quickly calculates:
$1.00 X 30% = $.30, and assigns a retail of $1.30 ($1.00 + $.30).
But that's a 30% markup. It's NOT a 30% margin. The margin in this case is actually 23%...A BIG difference. Below are a few formulas to help you calculate retails so you get what you expect.
If you know your cost and desired margin, here's how to calculate your retail:
Cost ÷ (1 - Desired margin %) = Retail
Example with $2.00 cost and a 30% desired margin: $2.00 ÷ (1 - .30) = $2.86 retail
You might round $2.86 to $2.89 for a more natural price point (and a few extra pennies of profit).
If you know your cost and your retail, here's how to calculate your margin:
(Retail - Cost) ÷ Retail = Margin
Example with $2.79 retail and a $1.50 cost: ($2.79 - $1.50) ÷ $2.79 = 46% Margin
If you know your cost and desired markup, here's how to calculate your retail:
(Cost X Desired markup %) + Cost = Retail
Example with $1.00 cost and 30% desired markup: ($1.00 X .30) + $1.00 = $1.30
Margin vs. Markup for calculating retails
In my opinion, it is better to use margin than markup. When reviewing financials at the end of a period, most retailers look at their margin as they evaluate performance. You're more likely to hit the right margin at the end of the period if you use margin to calculate your retails day to day.
A final word
Setting retails based solely on a desired margin is usually a mistake. Take some time to understand your competition's retails and the customers who shop (and might shop) your store before you make pricing decisions. More on this and techniques for raising your store's overall margin and profits in an upcoming blog.
CSA Regional C-store Consultant
Pacific Northwest Region