How to Calculate Markup: Best Practices for Managers

Properly pricing products helps attract customers to your business while supporting favorable profit margins. Calculating markup is a crucial part of creating a pricing strategy for your business. This article explains what markup is and how to correctly calculate it. 

 

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What is markup?

Markup is the difference between what you paid for a product and how much you’re charging customers. It’s typically expressed as a percentage. After you’ve determined your product’s markup, you’ll better understand your business’ gross profit margin. To calculate markup, you must know your overall costs, like labor, overhead and material. Understanding this helps you charge reasonable prices for products while still making a strong profit. 

Related: Building a Compensation Strategy for Your Business

 

Things to consider when calculating markup

Your markup should be strong enough to cover all of your current and upcoming business expenses and reductions like discounts, possible stock shortages and markdowns. Additional factors to consider when calculating markup include: 

 

Industry prices

Before calculating your own markups, research how competitors in your industry price their products. Average prices of products vary across industries. Most customers already have a clear idea of what they’re willing to spend on your product because they’ve seen the average prices for similar products. If they see your product priced at a higher amount than your competitor, they may purchase it at a different store.

Related: What Is the Definition of Low Hanging Fruit in Business?

 

Sales volume 

Certain products with a high sales volume usually have lower markups and still provide you with a large profit. Giving popular products low markups also makes customers want to buy more of their favorite items at affordable costs. 

 

Brand familiarity 

As your business grows, the popularity of your brand typically grows with it. Using marketing tactics to build brand awareness makes more people want to buy your products. Stronger brand familiarity can mean higher markups.  

 

Gross profits

To calculate your markup, know your business’ gross profit. This is the extra revenue you have available after paying the expenses for the product. 

 

Cost of goods sold 

Cost of goods sold (COGS) is how much you pay to produce your products and to keep your business operating. Your markup must be high enough to cover these costs: 

  • Rent for the building 
  • Insurance
  • Employee compensation 
  • Business supplies 
  • Freight 
  • Buying products for resale
  • Raw materials to make the product
  • Storage 
  • Shipping
  • Production equipment 

 

How to calculate markup 

To calculate product markup, you must know your expenses and gross profit and input them into a formula. Follow these three steps to calculate the markup of your products:

 

1. Determine your gross profit

Before finding your markup, find your gross profit with this formula: 

"Revenue – COGS = Gross profit." 

Your revenue is the income you earn after selling your products before deducting any other costs. For example, say you own a coffee shop and are determining the markup of a vanilla latte. If your latte brings in $5,000 each month and ingredients cost $2,000 each month, your formula would be: 

"$5,000 – $2,000 = $3,000" 

$3,000 is the gross profit for your vanilla latte. 

Related: What is the Bottom Line in Business? | A Guide for Managers

 

2. Divide gross profit by cost of goods sold 

Once you have the gross profit, divide this by your cost of goods sold to find your product’s markup. This formula is: 

"Gross profit / cost of goods sold = product markup" 

Using the earlier example, your gross profit divided by cost of goods sold would be how much your product markup is. Here’s what that equation looks like: 

$3,000 / $5,000 = 0.6 markup

 

3. Multiply the markup by 100 

Since your markup needs to be a percentage, you’ll convert it by multiplying the previous equation’s answer by 100. Here’s what it looks like: 

"Markup X 100 = final markup percentage" 

Here’s the markup percentage of your latte: 

0.4 x 100 = 40% markup 

 

Frequently asked questions about markup calculation

 

How do you calculate a 20% markup?

To calculate a 20% markup, take the price you paid for it and multiply by 0.2. If the price you paid was $30, your equation would look like: 

$30 x 0.2 = $6

 

What’s the difference between margin and markup?

Markup is used to determine your product’s price. The profit margin tells you how much revenue your business makes after deducting costs.

 

What is a profit margin?

A profit margin shows how profitable your business, product or service is. This is the percentage of revenue you have remaining after deducting other business or product costs.

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