When surveying business owners about how they determine their selling price, many say they use the 50% profit rule. The problem is that everyone’s “50%” produces a different selling price. That is due to confusion between markup and margin pricing. Small businesses lose significant potential revenue due to this markup vs margin mix-up. Markup and margin are not interchangeable. One is calculated relative to cost, while the other is calculated relative to selling price. Because of the mix-up, every invoice that gets sent out is underpriced.
This guide describes the confusion between markup and margin pricing. It also describes how to calculate markup and gross margin, and the price of calculating either incorrectly. By the end of the guide, readers will be able to calculate the price for profit without relying on guesswork.
Markup is typically the selling price of a product above its cost, expressed as a percentage of cost. It typically answers the question, “How much am I selling it for in comparison to how much I paid?” If the item cost you $50 and you sold it for $75, the profit would be $25. Because markup is measured as a percentage of cost, the $25 profit divided by the $50 cost yields a 50% markup. It is likely that retailers, wholesalers, and contractors will think in terms of markup first, as it is easier to create a price from a cost.
Margin, or gross margin, is the percentage of profit for that sale, expressed as a percentage of the selling price. Considering the same example as before, that $25 profit would be divided by the $75 selling price, yielding a 33.3% gross margin. It is the same sale and the same profit in dollars, but the percentage is different. Margin is the metric most accountants, lenders, and investors focus on, as it measures profit per sale.
The markup vs margin confusion comes down to what each one measures. Typically, margin is the lower of the two. Understanding the difference in markup and margin measurement would clarify most pricing confusion.
| MARKUP | MARGIN | |
| Measures profit as a % of: | Cost (what you paid) | Selling price (what the customer paid) |
| Formula | Profit ÷ Cost × 100 | Profit ÷ Selling Price × 100 |
| Example ($40 cost, $60 price) | $20 ÷ $40 = 50% markup | $20 ÷ $60 = 33.3% margin |
| Best used for | Quick cost-plus pricing | True profitability tracking |
Figure 1: Markup vs margin, side by side, using the same $40 cost and $60 selling price example.
Markup calculations start with costs. Find the gross profit dollars by subtracting the cost from the selling price. Next, divide that profit by the cost (not the selling price). Multiply that answer by 100 to get the markup percentage. For instance, a selling price of $60 and a cost of $40 leave a $20 gross profit. Take that profit and divide it by the $40 cost to get 0.5, or a 50% markup. This formula is universal, whether pricing goods for a retail sale, billing for an hour of service, or quoting a wholesale order: (profit/cost) * 100.
Calculating gross margin starts the same as gross profit, using the same cost and selling price. This time, however, you divide the gross profit by the selling price, then multiply by 100. Following the same example, with a selling price of $60 and a cost of $40, a gross profit of $20 divided by $60 selling price leaves a 33.3% gross margin. For the same transaction, a 50% markup was earned, illustrating that the difference in the formulas is purely attributable to what you divide by.
No, and this is exactly where business owners start losing money. A 50% markup on a cost of $40 results in a selling price of $60 and a margin of 33.3%, as shown above. However, a 50% margin on a $40 cost requires a selling price of $80. The $40 profit divided by the selling price of $80 equals 50%. That’s a $20 difference in the selling price of the same product, and is the result of markup versus margin confusion. If the goal is to achieve a 50% profit margin and a 50% markup is used, all sales are effectively being undersold.
This error is more than theoretical because it directly involves cash flow. A small retailer attempts a 40% profit margin across their product lines. In this case, if the retailer thinks a 40% profit margin and a 40% markup are equivalent and applies a 40% markup, they will end up with a margin of 28.6%. When this occurs over thousands of transactions in a year, the lost profit that could have gone to employees, inventory, or business expansion will add up to tens of thousands of dollars.
A similar result occurs when contractors apply a 30% markup, believing it delivers a 30% profit margin; in reality, the real margin is closer to 23%. After a year of underpriced bids, the resulting gap can be the difference between a business that grows and one that is continuously fighting cash flow problems.
This is also a cumulative error. Business owners who fail to account for cash flow, inflation, or rising costs and instead erroneously calculate markup rather than margin will lose profit over time.
As markup and margin only match at 0% (and otherwise never match at the same percentage), a quick guide to converting is useful. The table below shows some markup percentages and the corresponding gross margin that would result.
| MARKUP % | RESULTING MARGIN % |
| 10% | 9.1% |
| 20% | 16.7% |
| 25% | 20.0% |
| 33% | 24.8% |
| 40% | 28.6% |
| 50% | 33.3% |
| 66% | 39.8% |
| 100% | 50.0% |
| 150% | 60.0% |
| 200% | 66.7% |
Figure 2: Common markup percentages and their resulting gross margin. Notice how the gap between the two widens as the percentage climbs.
According to the chart, the gap separating markup and margin is significant at higher percentages. Doubling the cost to create a 100% markup results in a 50% margin. Tripling a cost to create a 200% markup offers a 66.7% margin. At higher percentages, most owners are incorrect in assuming that margin and markup are closely related.
If you have a specific gross margin goal, you can determine your selling price without relying on a guess about a markup percentage. To do this, start with your cost, then divide this amount by one minus your desired margin percentage as a decimal. For example, say you have a cost of $30 and a gross margin goal of 40%. Subtracting 40% from 100% leaves you with 60%. $30 divided by 60% is $50.
To check the math, if the cost to produce the product is $30 and the selling price is $50, you profit $20. The profit margin at a selling price of $50 is 40%, confirming the goal has been reached. This pricing-for-profit method can be applied to any gross margin goal and is preferred by accountants and pricing consultants because it provides a high degree of confidence that the margin is correct, rather than estimating it based on a markup.
Variations across industries create confusion when using the words markup and margin. However, there are certain considerations when using them across industries. Retailers will use markup due to its connection to the supplier invoice. Grocery and general merchandise stores face intense price competition, so they think in terms of margins. This typically results in a 20%-30% margin range for these industries. Restaurants usually operate with a target gross margin of 65%-70% on food, meaning food costs of 30%-35%.
Service businesses and software companies have greater pricing power, leading to gross margins of 70% or more. This is due to lower direct costs of delivering their service relative to their price. Contractors and manufacturers think in terms of both margin and markup. This is due to the quick changes in the costs of materials, labor, and equipment. Understanding the pricing models in your industry will help you communicate effective pricing strategies.
Even when business owners learn the concepts of markup and margin, mistakes still arise. One of these is business owners calculating the cost of goods sold without including all costs. Some forget the cost of shipping and packaging, and this creates a false margin that business owners think they are earning.
Many set a target margin and never change it, even as supplier prices change. Again, this changes real profitability, but this is problematic since it is hard to identify without a large change. Also, service pricing is on an hourly basis, but unbilled admin tasks and travel time quietly erode the margin actually earned. Many of these mistakes can be avoided by simply reviewing true costs on a per-unit margin basis rather than a markup basis.
In retail and wholesale, markup works really well to support fast, cost-based pricing decisions. This is largely due to the prevalence of “cost plus markup” pricing in the market. Margin, however, is what you will find most directly correlated to your income statement and your actual take-home profit.
When a lender evaluates your business for financing, when you assess your business performance from one year to the next, and when you compare your business to your competition, gross margin is the term commonly understood. If you only rely on markup, you can have a false sense of profitability, while your real margin is eroding, especially when costs go up and you don’t increase your price to support the margin percentage you planned.
The safest habit is asking what number is in front of you. Do not assume markup and margin can be used in the same manner in conversation, in a spreadsheet, or in a client quote. When supplier prices increase, use the margin to recalculate the selling price. This will keep your profitability consistent. Use a pricing sheet for your daily pricing. It should have cost, target margin, and a selling price. This will bring alignment and simplify your pricing decisions.
Markup and margin represent the same profit in dollars but express it as two very different percentages. Markup is defined as profit divided by cost, whereas margin is profit divided by selling price. Perhaps one of the more common pricing errors, and one of the more costly mistakes, is confusing markup and margin, which leads to lost profit on every single transaction. Understanding the markup (or margin) formula and being able to compute it accurately allows you to price your product or service deliberately, rather than at random.
Whether you own a retail outlet, offer a service, or run a contracting business, protecting your gross margin means safeguarding your ability to pay employees, grow your business, and maintain your overall financial health and stability in the long run. Take a few minutes to analyze your current pricing and your target margin. You may find that your pricing is missing your margin target and that you are leaving profit on the table.
Markup is defined as profit shown as a percentage of cost. Margin is profit shown as a percentage of the selling price. Since, on a profitable sale, the selling price is greater than the cost, the margin will always be a smaller percentage than the markup for the same sale.
First, find the gross profit (selling price minus cost). That profit is then divided by cost and multiplied by 100 to get the percentage. A $20 profit on a $40 cost is 50%, the markup.
To calculate gross profit margin, subtract the costs from the selling price to calculate gross profit, divide the gross profit by the selling price, and multiply by 100. A $20 profit from a $60 selling price gives a gross margin of 33.3%.
No. A $40 item marked up by 50% would sell for $60, with only a 33.3% margin. To achieve a 50% margin on a $40 item, the selling price would need to be $80.
To find the selling price, divide your cost by 1 minus your target margin. If your cost is $30 and you want to target a 40% margin, you would divide $30 by 0.60. This tells you the selling price would be $50.
