Difference Between Profit Margin and Markup Explained

You may have hated math in high school, but it's time for an important lesson - one that can make the difference between being in the red and being in the black.

The terms "margin" and "markup" actually represent the same thing, but from a different stage of a sale. Markup represents a monetary amount of a product or service before a sale, while margin represents that same monetary amount after a sale. Some confusion can come up between these numbers, especially when represented as percentages, but that's what you're going to be able to avoid once you're done reading.

Let's say you're a retailer who buys widgets at $50 each to sell to your customers. You obviously can't resell those widgets at less than $50 or else you wouldn't be making any money and wouldn't be able to cover your costs. So you increase (or mark up) the selling price to $70. That extra $20 is your markup. As a percentage, that's a 40 percent markup. In other words, you're selling that widget for 40 percent more than you paid for it.

The math to find out markup percentage is:

Selling Price minus Original Price equals Markup (e.g. $70 - $50 = $20)

Markup divided by Original Price equals Markup Percentage (e.g. 20/50 =.4; you then multiply by 100 to get the percentage of 40 percent)

If you don't sell any widgets you still have a markup, but you don't yet have a margin. You haven't actually made any money, so you don't have a profit margin (note: "margin" here refers to "gross profit margin" because we haven't taken into account your overhead costs).

Once you sell that widget, you've made your $20 which is now your margin. This $20 is the same $20 as your markup. However, if you want to calculate what percent profit margin you're getting, it's a little more than 28 percent.

Here's the math to figure out margin percentage:

Selling Price minus Original Price equals Margin (e.g. $70 - $50 = $20)

Margin divided by Selling Price equals Margin Percentage (e.g. 20/70 =.285714; you then multiply by 100 to get the percentage of about 28 percent)

So even though you marked up the product 40 percent, you're only making a 28 percent margin. Again, the dollar amount for your margin and markup are exactly the same, but the percentages are different.

So what difference does all this make? Well, if you've figured out that you need to have a 37 percent margin in order to cover your costs and make a reasonable profit you can't just markup your product 37 percent. You'll have to work backwards to find out how much you should sell your widget for.

This math for what your selling price should be gets a big more complicated, but you can do it:

Original Price divided by 1 minus the Margin Percentage equals Selling Price. So if the widget costs you $148 and you need a 37 percent margin, the selling price is: 148/(1 -.37) or $234.92, which is actually a markup of nearly $87 dollars or almost 59 percent.

Some people like giving these types of examples with nice, clean, easy-to-use numbers, but real-life numbers aren't always that way. Practice these equations with numbers from your business and you'll get some analysis that may surprise you.

Scott Spjut is a writer and editor who has been featured in various magazines, newspapers and websites, including Newsweek, the Washington Post, CBS News and the Las Vegas Review-Journal. With a B.A. in Communications, he continues to write on a wealth of topics - politics, health and fitness, business, marketing and more. Scott currently works with Professional Marketing International helping people change their lives.