Today I encountered an interesting problem. It turns out that for many people, the concepts of markup and profitability are not different. When talking about the profitability of selling goods or services, they freely use one term or the other, not seeing the difference between them. In absolute terms (in money), there really is no difference, but when using relative values, the difference turns out to be significant. Let me give an example. I bought some gadget for 100 UAH, decided to sell it with a markup of 20 UAH (an absolute value) or 20% (a relative value). So what will the profitability of this sale or the marginal income be? Those who answer — 20 UAH, of course, will be right, but those who answer 20% — will make a mistake!
20% markup does not equal 20%
profitability (margin)
Because the profitability of this sale in relative terms will be 16.67%. (Accountants know this figure well.)
So what is the difference and why does it matter? It’s quite simple. If we assume that:
Selling price = 120 UAH
Cost price = 100 UAH
Then markup in absolute numbers is: 120 UAH — 100 UAH = 20 UAH
in relative numbers (percentage): (20 UAH / 100 UAH) * 100% = 20%
In turn profitability in absolute numbers: 120 UAH — 100 UAH = 20 UAH
in relative numbers (percentage): (20 UAH / 120 UAH) * 100% = 16.67%
Thus, to calculate markup as a %, you need to divide the absolute value of the markup by the cost price of the gadget and convert it into a percentage. To calculate profitability, you need to divide the absolute value of the markup by the selling price and convert it into a percentage.
Why is this important? Because if you decide to offer a discount greater than 16.67% (in this example) when selling, you will sell for less than you paid. In other words, you will incur a loss.
Any percentage discount that exceeds your margin (%) will result in selling below cost.
If you decide to give a 20% discount when selling (in our example) and think that at least you’ll get your money back, you would be mistaken. By giving a 20% discount on a gadget you were selling for 120 UAH, you will end up with only 96 UAH. That means you’ll lose 4 UAH. Unfortunately, this mistake is quite common. Don’t fall for it.
