At Tom Vignali CPA, Inc.,we are often asked, “How come when I mark up the cost of a product, it is never equally reflected in the Gross Profit Margin (GPM)?” Clients often assume that marking up the cost of a product to a sales price should be reflected in the GPM. It’s a common mistake and very easily resolved.
GPM and Markup are distinctly separate accounting terms, which use the same financial inputs to analyze the same financial transaction, yet are calculated differently and reflect different financial data.
What Gross Profit Margin Means
The GPM reflects the profit a company makes after paying for the costs of goods sold (COGS). A client has X amount of money left over after selling their product/service. One arrives at this calculation by taking the revenue minus the COGS. The difference is shown as a percentage of revenue. The percentage of revenue that is the GPM is found by dividing the GPM by the revenue. If a client sells a product/service for $100 and the COGS is $70, the GPM is $30 or 30% respectively.
$30 / $100 = $30 or 30%
What Markup Means
The Markup is the price being charged for a product/service minus the COGS of that product/service. In this instance, the “Markup” is the amount of increase a company charges above the COGS. The client “marks up” the cost of a product/service by X amount. If the same numbers of $100 and $70 are used, the calculation would be $100 revenue minus $70 COGS divided by $70 COGS resulting in a 42.9% markup percentage.
$100-$70 / $70 = 42.9%
Here is a guideline connecting GPMs to Markups:
10% GPM = 11.1% Markup
20% GPM = 25.0% Markup
30% GPM = 42.9% Markup
40% GPM = 66.7% Markup
50% GPM = 100% Markup
To calculate other Markup percentages, the calculation is:
Desired GPM / GOGS = Markup percentage
Same Figures, Different Results
So although the same financial figures are used, the calculations reflect entirely different results.
In one instance, the calculation reflects how much above the COGS the client will charge. In the other, the GPM reflects how much money is left over after the sale of the product/service. It is easy to understand how a client might confuse these two critical calculations. Clients are often dismayed by the resulting financial data when they mark up the cost of a product/service by 43% only to discover that their GPM is not 43% but only 30%.
Why Both Calculations are Important
We work extensively with our clients to provide guidance on both of these financial calculations. In one instance, the markup results in a sales price which might or might not be competitive in the marketplace. In another instance, the GPM might not be adequate to support the operational costs of the business. Review of both of these financial calculations is critical to maintaining business viability.
If you would like to further discuss this issue or any other accounting matter, don’t hesitate to contact us at: Tom Vignali CPA, Inc.
Contact Us:
Thomas W. Vignali CPA Inc.
118 Point Judith Road
Narragansett, RI 02882
T: (401) 415-0798
tom@tomvignalicpa.com
www.tomvignalicpa.com
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