Before we get into some numbers, which I am sure you are desperate to do, as all accounting students are, let’s look at the differences between mark up and margin. Before I do that, just remember that cost + profit = sales price, and conversely, sales price – profit = cost.
Mark up is where we are using the cost of the product to calculate the profit that we want to make. Once we have calculated the profit, we add this to the cost price, and this is the amount that we will charge our customers. Say for example we had a product which costs us £200 to make, and we want to add a mark up of 30% on this, the profit that we will add on will be £200 x 30% = £60. Therefore, when we add the profit to the cost to come to a sales price of £260.
Whereas with margin we are using the sales price of the product to calculate the profit that we want to make. So, we will start with the sales price, deduct the profit that we are going to make, and that will leave us with the cost of the profit. So let’s look at an example, if we sell a profit for £260 and we want to make a profit margin of 30%, we will have a profit of £260 x 30% = £78. We can then take this from the sales price to come to the cost of £182.
Note that in these examples we have the same profit percentage and the same sales price, but the profit and costs are different. DO NOT mix these up, you will get the answer wrong.
Advantages and disadvantages
I know you are desperate for some numbers, but I will keep you a little longer, let’s talk about the advantages and disadvantages of both.
With margin we are using the sales price to dictate the profit, so we will set the sales price and then calculate the profit. The advantage of this is that we can set a price that is competitive compared to our competitors. The downside of this is that the cost price is whatever we have left after we have deducted our profit, and this might not be enough to cover what it actually costs to produce your product, so you might be making a loss.
With mark up we are adding the profit to the cost, so we will always be making a profit. The downside is that the price is whatever the cost plus the profit is, and it doesn’t take into account what your competitors are charging, so you might end up being a lot more expensive than your competitors.
AAT Level 3 and 4
At level 3 and 4 we might have to work some of the costs and or sales price backwards, which is a little trickier, but remember that the figure that we are starting with is always 100%. If we have a product which costs £80, and we have a profit margin of 20% of the sales price, we know that the cost must be 80% of the sales price. We can then work backwards to come to the sales price, if £80 is 80% of the sales price, we can divide by 80 to get 1% of the sales price, and then multiply by 100% to get 100% of the sales price. The calculation would be £80/80 x 100 = £100.
With margin the figure we start with is the cost, so the cost is 100%. Under mark up, we would add a percentage to the cost to come to the sales price. If we have a mark up of 20% and we have a sales price of £100, the profit ISN’T £20. We have added the profit to the cost to come to the sales price, so the sales price is 120% of the cost. Then in our example, we could divide the sales price 120 to get 1%, and then multiply by 100 to get the original cost price. The calculation would be £100 /120 x 100 = £83
Why don’t you have a go at the following questions:
- If a company has a product it sells for £720 which includes a mark up of 20% what is the cost of the product to make?
- A company has a profit margin of 30% and sells a product for £800 what is the cost of the product?
- A product costs £300 to make and the company sells it with a profit margin of 40% on the sales price, what is the sales price?