When it comes to pricing your projects, markup and margin each have their own purpose. Their similarities make them easy to confuse, but you don’t want to mistake them when you’re setting your prices.
The basic formula for calculating project pricing is:
Project Cost + Gross Profit = Sell Price
Margin is the ratio of gross profit to sell price.
Margin = Gross Profit / Sell Price = (Sell – Cost) / Sell
Also referred to as gross margin or target margin, this answers the question: how much will I (or did I) make on this sale (before taxes and overhead)? It is useful when you know the project cost and sell price, or in setting targets based on how much you want to make.
Markup is the ratio of gross profit to project cost.
Markup = Gross Profit / Project Cost = (Sell – Cost) / Cost
This answers the question: how much should I add to my project cost in order to determine my sell price? It is most commonly used when you know the cost of a project and your target margin, and you want to determine the sell price.
To simplify the math, it is often represented as a cost multiplier by adding 1 (or 100%) to the target ratio.
Markup as a ratio or percentage:
Project Cost + (Project Cost * Markup) = Sell Price
Markup as a multiplier:
Project Cost * Markup = Sell Price
Over the course of establishing prices, it’s likely that you will use both the markup and margin. When it comes to making sure that you’re charging enough, it’s important to use the right one in the right context.
You can find the markup multiplier based on your target margin:
If this is true:
Markup = Sell / Cost = Sell / (Sell – Margin * Sell)
Then this is true:
Markup = 1 / (1 – Margin)
Margin = 1 – (1 / Markup)
Real World Example
If it costs $60 to build a chair, and you sell it for $100, your gross profit is $40. Your margin is 40% (of the sell price) and the markup is 67% (of the project cost).
If you know your cost and the gross margin that you’d like to make, you can easily calculate your sell price.
$60 * 1 / (1 – 0.4) = $100
If you think you need a margin of 40% to cover your overhead and turn a profit, you’ll be in trouble if you use a markup of 40% to arrive at your sell price. A quick Google search will also reveal that conversion charts and calculators are also available for checking the math.
If you leverage a quoting tool, like Ascend, the markup conversion is built in automatically. Still, it’s important to understand how your current process translates. It also helps to be able to check your math with your books to make sure you’re charging enough.
Keep your project-based business healthy. Set your project pricing up correctly, so you can hit your target profit margins.