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From March 2012

Money matters: Mark-up versus Gross Profit margin – there is a difference!

Gross profit, as I have said for the last decade in this publication, is the key performance indicator when looking at growing your financial position.

I am still incredulous that companies still just keep talking about sales and comparing their financial performance based on a top line number from the Profit & Loss statement. This apparently portrays the company’s overall financial position.

Yes, sales are important, but everyone in your business needs to have an understanding of what Gross Profit is, what affects it and how to improve it.

So what is it? Simply, Gross Profit is the difference between the sale price and the cost price. 

The first rule of retailing is that if a product costs $100, then you should sell it for more than $100. (There are products known as loss leaders where this is not the case, however good retailers use these items to sell other products with a good margin.)

Gross Profit margin is another simple concept. If a pipe fitting sells for $5 and costs $2.50, the Gross Profit result achieved is $2.50. As a gross profit margin the result is 50% ($2.50 divided by the sales price of $5 x 100).

What I find puzzling is that there are still people in this industry – even a majority I believe – who think that if they mark up a product by 50% then they make 50%. 

I know when I do a simple pricing exercise in my workshops generally only 10% to 20% of the attendees get it right…

Try this quick quiz: 

  • Product costs $100 excluding GST. 
  • Gross Profit margin required is 25%. 
  • The price must include GST.
  • The answer is at the bottom of this page (note the answer is not $143.75).

To answer this question it is important to understand mark-up. Mark-up is the profit obtained from the sale of the product when expressed as a percentage of the cost price. 

In the example above it is sales price minus cost price divided by the cost price. That is $5 minus $2.50 cost price divided by $2.50 and multiplied by 100. The mark-up is 100%.

This shows that a 50% Gross Profit is in fact a 100% mark-up and confirms that they are two completely different percentages.

If staff cannot grasp this concept it can lead to substantial loss of profits. In particular if say the average overhead percentage for the store (that is wages, rent insurance etc.) is 25% of turnover and staff are marking up products by a factor of 25%, you are not breaking even! In fact the Gross Profit margin is 20%. 

Look at the table below:

money-table.jpg

To achieve a Gross Profit margin of 25% you need to mark up by 33.3%.

My experience again is that staff can be confused with the difference between mark-up and Gross Profit. Just reviewing the chart above it is obvious that this problem can be detrimental to the profit of your store. You could be losing 5% and not even be aware of it.

Again one of the major reasons why merchants are not achieving the desired dollar Gross Profit is through a trick in mathematics. Of course there are more than 30 other factors that can affect your gross profit result, such as not booking out, theft, paying for stock not received etc. 

However the easiest way of improving your Gross Profit result is to be clear about the difference between mark-up and Gross Profit margin.   

 


The calculation and answer to the question posed above is as follows: $100 cost price x 1.3333 (33.33% mark-up) x 1.15 (15% GST) = $153.33.



The author: Peter Cox is is a regular contributor to NZ Hardware Journal and a senior consultant for Macquarie Advisory Partnership based in Sydney. He has over a decade of experience training and consulting in the retail hardware industry. He conducts key-note addresses, and management and sales workshops, which are aimed at improving profitability and liquidity in one of Australasia’s most competitive retail environments. Phone 0061 438 712 200, email peter.m.cox@bigpond.com or visit www.petermcox.com.au