Growing your own small business or online wholesale ecommerce store is an incredibly rewarding and exciting experience.
But if you’re someone who isn’t super familiar with business lingo and marketing terminology there might be some things that leave you scratching your head. You may hear the terms like “markup” and “margin,” but what do they mean, and why are they important?
Simply put—both the profit margin and markup are two parts of the same transaction. The profit margin shows profit as it relates to a product’s sales price or the amount of revenue generated, while the markup shows the profit as it relates to costs of goods sold.
Markup and margin are both accounting terms that you’ll regularly come across as you operate the financial side of your business.
Markup vs margin: the key difference
Markup is the percentage increase on a product’s cost price to determine the selling price, indicating how much to add to cover business costs. Margin is what’s left over after sales are deducted from the cost of goods sold, which represents the profit.
What is a margin?
In ecommerce, the fundamental rule is that merchants must list products at a price higher than the cost of acquisition or production—this is the cornerstone of generating profit. This difference between the cost of procuring a product and the price at which you sell it on your online platform is known as the profit margin. In other terms, the margin represents an ecommerce business’s revenue remaining after settling the cost of goods sold (COGS).
The profit margin formula is:
Profit Margin = Net Sales / COGS x 100
Profit margin includes the total sales revenue before deducting any tax or other expenses. Most businesses will use the gross profit margin to provide crucial insights into how effectively they use their resources to make and sell goods or services.
The operating margin includes the costs of products sold, costs associated with selling and admin, and the overhead. It’s important because the operating margin measures how much profit a company makes after deducting variable costs. These include manufacturing costs and wages if you employ people. This margin will help investors analyze a company’s value and profitability.
Last is the net profit margin. This margin percentage is calculated after deducting all expenses and taxes from the business’s overall revenue, and it is then divided by net revenue. The net profit margin—also referred to as the bottom line—is a very important margin for indicating a company’s overall financial health and ability to grow.
When should I use margin?
When you want to assess your business’s profitability and ensure fixed costs are covered, margin is essential for understanding the profit percentage of each sale.
Throughout your journey in ecommerce, you’ll likely encounter three categories of profit margin: gross profit margin, operating margin, and net profit margin. Each of these plays a critical role in your online store’s financial health, and we’ll delve deeper into their individual implications below.
What is a markup?
A markup is the amount by which the cost of a product is increased to get to the final selling price.
For example, if you purchase or manufacture something for $80 and sell it for $100, you have made a profit of $20. The markup percentage of profit ($20) to cost ($80) is 25%. This would give you a 25% markup on your product. The markup price is related to the profit margin, but they are not the same thing and can be confused.
Here’s the markup formula:
Markup = Profit / Cost x 100
When should I use markup?
When setting retail prices, use markup to make sure you cover both costs of goods and operating expenses, and to make sure you’re making money.
Why know the difference between margin vs. markup?
Both the profit margin and markup are two parts of the same transaction. The profit margin shows profit as it relates to a product’s sales price or the amount of revenue generated, while the markup shows the profit as it relates to costs of goods sold.
It’s really easy to see how you can confuse the profit margin and the markup, and errors in mixing up the two can lead to business owners either undervaluing or overpricing their products, which can impact your profit and the success of your business.
It’s important to understand exactly what the two mean and how they affect your bottom line so that you can price your products effectively. There are a lot of administrative tools available online, including Profit Calc and BeProfit, which are designed to make accounting easier and more efficient.
How to calculate margin
So you have a product you’re proud of and you’re ready to sell it online: How do you calculate a healthy net profit margin? A good margin will vary considerably, depending on the industry and size of the business. That said, it is generally thought that a 10% net profit margin is considered average, while 20% is high (or “good”). A 5% net margin is considered low.
It’s important to consider that this is simply a guideline and may not apply to your products or services. It’s also important to note the percentages for your gross, operating, and net profit margins will vary because they represent different areas of the business.
You can use Shopify’s wholesale profit margin calculator to help you figure out what the best profit margin should be for your business.
How to calculate markup
Let’s look at an example of markup percentage calculation. If it costs a vendor $50 in materials and labor to make a beautiful rug, and they sold that rug for $80 on Faire, the profit margin would be $30. Calculated into a percentage would give you a margin of 37.5%.
Using the same example of the rug, the markup is the difference between a product’s selling price ($80) and its cost price ($50)—the markup price is $30—but looking at the equation from a different perspective (with a percentage that’s calculated by dividing markup price by what is the cost to make the rug), the markup percentage is 60%.
What is a good margin?
A “good” margin in ecommerce depends on factors like the industry, the business type, competition, market positioning, and product type. Most ecommerce businesses aim for a 30% to 40% gross margin; however, businesses selling luxury items or specialized products might aim for higher margins, while high-volume, competitive sectors might have slimmer margins.
Ultimately, a good margin is one that supports operating costs, allows for competitive pricing, and makes a profit.
What is a good markup?
In the same way that there is a general rule of thumb for looking at profit margins, the same goes for calculating the markup. Most companies will set an average retail markup—also known as a “keystone”—of 50% or 60%, but it really depends on product and industry.
Luxury goods have a much higher markup, while small kitchen appliances, for example, tend to have a lower markup. Your markup percentage may also vary as your business grows.
When figuring out how high or low your markup percentage should be, here are some basic principles to consider:
- If you have low prices, then your markup percentage should be higher.
- If you can produce and sell inventory quickly, you should have a lower markup.
- Everyday products should have a lower markup than unique, one-off items.
- Take a look at your direct competition: what are their markups?
While it might be tempting, having a high markup isn’t beneficial, especially when you’re growing your small business. It might deter customers, and you might struggle to sell anything at all.
Set your markup price too low, and you’ll barely be making any profit at all. This is why 50% is considered a safe bet—it ensures you are earning enough money to cover the costs of manufacturing while also earning a healthy and steady profit.
Using markup and margin in your business
Choosing between using markup or margin in your ecommerce business depends on your goals and pricing strategy. Here’s what to consider:
- Overheads. If you want to guarantee you’re covering costs and achieve a specific profit, markup is the most straightforward method. It’s calculated based on the cost of a product.
- Profitability analysis. If you want to understand profit in relation to sales revenue, you may want to use margin. It helps you see the exact percentage of each sale’s profit.
Some industries prefer one method over the other. Retail often uses markup, while industries with complex cost structures might prefer margins.
In practice, successful ecommerce merchants often calculate both figures. Initial prices are set using markup, whereas margins are monitored to measure profitability, analyze operations, and compare profitability with industry benchmarks. A robust pricing strategy requires understanding both.
