A business’s gross profit is an essential KPI that business owners must understand. To eliminate confusion, let’s delve into the distinctions between two key metrics: margin and mark up. The business owners know what they mean, but accountants use a strict definition, and there needs to be more clarity. Here’s a quick guide.
Firstly, what is gross profit?
Gross profit is the difference between what you sell an item for and what it costs to make, buy, and deliver to your customer. It is a vital key performance indicator (KPI) that assesses a business’s financial health. Look at the illustration below to see how gross profit is calculated.
The gross profit achieved can be expressed as a percentage, and the two main types are markup and gross profit margin.
Mark up, often denoted as a percentage, is calculated based on the cost of the item. It reflects the amount added to the cost to determine the final sales price. In other words, what we add to the cost to calculate the sales price. For instance, if a business marks up a product by 100%, with an initial cost of £1,000, the selling price would be £2,000. This calculation is depicted below:
Gross Profit % or Margin
This is expressed as a percentage of the sales price. So if our sale price is £2,000 and the cost is £1,000, our gross profit is £1,000. As a percentage of sales price, this is 50%. See below
In summary, the key difference between margin and markup lies in their reference points. Mark up is determined as a percentage of the cost, whereas gross profit margin is expressed as a percentage of the sales price. Both metrics are invaluable for assessing a business’s profitability and financial performance.
Understanding these concepts is essential for effective financial management and strategic decision-making within your business. Whether you are a business owner or an accountant, clarity on these terms is matter for success in the world of commerce.