Making Markup Work for You: A Calculation Guide for Small Business Owners
Pricing is one of the most important parts of starting your business. Set your prices too low and you’ll lose money. Set them too high and you could miss out on clients.
Many different things go into pricing, from material and labor costs, to overhead like office rent and bills. On top of all your expenses, and sales coming (or revenue), you still need to make money and profit. After all, without profit, your business won’t be able to grow.
That’s where markup and profit margins come in. Both contribute to your bottom line and have a direct impact on your pricing.
In this resource, we’ll focus on markup and answer questions like:
What is markup?
Markup is how much more money you charge for a product or service after costs to help ensure a stable profit. It can be measured as a dollar amount or a percentage.
What’s an example of markup?
For example, let’s consider fertilizer for a lawn service business.
Say you purchased the fertilizer through a wholesale supplier, and it cost you $10 a bag. Then you charge your client $25 for the fertilizer. The markup is the difference between the material cost to you ($10), and the amount you charged to the customer ($25). In this case, the markup is $15, or 150%.
Markup can be applied to both products and services and can even vary per client or job.
While it’s good to have a standard markup value, you can have some wiggle room.
For example, if a lawn care client has a huge yard and needs a lot of fertilizer, you could potentially offer them the fertilizer at a discounted price while still making money.
The key here is to know your profit margins well enough to ensure that you’re still making money (or breaking even) when you do this.
What’s the difference between profit margin and markup?
Profit margin is the difference between your sales and your costs (materials, payroll, utilities, price adjustments) after a job.
Markup is the difference in price between your costs and what you charge a client to help maintain or boost your profits.
For example, let’s say you completed a job and you charged the client $500, but the job only cost you $400 to complete.
Your profit margin would be $100, or 20%
Your markup in this instance would be $100, or about 25%.
Both markup and profit margin can affect each other. If material costs are unusually high for a job, it can negatively affect your profit margin on a specific project. If you underestimate labor costs, this can also negatively affect your profit margins.
Likewise, if material costs and labor costs are low, you could see a positive change to your profit margin.
Strike a healthy balance between the two
Evaluate your markup too low, and your profit margins may not be high enough to sustain your business.
Evaluate your markup too high, and clients may choose to find a more affordable service provider who has a lower markup.
Use both markup and profit margin to set these values
You can use your profit margin to inform your markup. This can help to keep your pricing in check.
For example, if you set a goal to have a profit margin of, say, 30%, then work backwards to know how much you need to make from each job (on top of material costs) to reach that goal (roughly 40%).
Markup on your products and services can help you to stay within a comfortable profit margin range. It can also ensure that you’re making a fair profit from each job as well.
How much should my markup be?
The amount of markup you charge really depends on your business, the market, and your profit margin goals. The good news is that profit margins and markups correlate in a very predictable way.
So, if you know your profit margins (or what you want them to be), you can easily determine your markup.
If you’re aiming for a 40% profit margin, you can see that you need to charge about a 70% markup on your product or service.
Alternately, if you want a 50% profit margin, you need to have a 100% markup.
Use this chart to roughly determine the markup estimate that fits your profit margin goal:
How do I calculate markup?
Calculating markup is relatively straightforward once you know how much you need to charge.
In order to do that, you need to factor the following into your pricing model to start:
- Cost of labor
- Cost of Goods Sold (COGS)
- Operating costs
- Other expenditures
Then, use the chart above to determine how much your markup should be in order to meet your profit margin goal.
Once you have an ideal profit margin, you know how much you need to charge over and above material and labor costs to get to it.
Let’s say you have a 50% profit margin goal. That means that you need a 100% markup on your product or service. If your base costs were $100, a 100% markup would mean that you charge $200 total.
It’s a good idea to work out a few models for this to help you understand the flexibility of your markup values. So if you’d like to charge less or more, you understand the impact it has on your business.
Pro tip: When it comes to accounting for your overhead expenses such as rent, utilities, and salaries in job costing, accounting software will help you work this into a high level pricing strategy. However, things start to get complicated when you try to apply this to a specific job.
You might include an overhead recovery fee in your pricing strategy as a solution.
It’s best to speak to a professional accountant to help you understand how to create a sustainable markup and pricing strategy for the long term.
How do I figure out what my current markup percentage is?
To start, you’ll need to know your:
- Revenue (revenue is the income dollar amount you’ve generated from operating your business, selling goods, and selling services.)
- Cost of Goods Sold (COGS)
- And gross profit (the profit made after deducting COGS, expenses, the cost of operating, and payroll)
First, take your revenue and subtract your COGS. This will give you your gross profit.
Gross Profit = Revenue – COGS
Then, to get your markup, divide your gross profit by your cost of goods to get the dollar amount. To turn it into a percentage, just multiply it by 100.
The markup percentage formula goes like this:
Markup = (Gross Profit / COGS) x 100
Why is markup important?
Markup is important because it helps you to ensure that you’re making enough money to not only stay afloat, but to grow and expand.
For example, with the money made on markup, you can invest money in your business by:
- Sourcing better talent
- Offer better salaries to your team (and yourself)
- Training employees
- Buying benefits programs for your team
- Start marketing your business
- Afford better materials
Although it can change based on several different things (supply costs, market value, competitors, and even individual jobs), it’s one of the deciding factors in whether you make a profit or not.
By striking a balance within your pricing structure, you can offer your clients and customers fair prices while still making enough to move your service business forward.