In order to find success in the beverage alcohol business, entrepreneurs need to have an understanding of their financial metrics. In this video, Nolan Batalha, Accounting Manager at GHJ, describes the difference between margin and markup and explains how each should be calculated. Batalha also reveals the different types of margins and markups and some key terms related to each.
“[Contribution Margin] is an important metric for investors so it’s important to understand what it represents,” explains Batalha. “Contribution Margin is just our total revenue less our variable cost.”
The Difference Between Margin and Markup
Nolan Batalha 0:09
Hello everyone, my name is Nolan and today we are going to talk about margin versus markup. Now these are very confusing terms, and people oftentimes mix them up, so it’s important to dive deeper, look at some definitions, and examine an example or two so we fully understand what they mean and what they represent. Let’s start with margin. Margin is just the measure of your business’s profitability, represented by a percentage where we analyze the profit as it compares to revenue. On our income statement, we have different types of profit: we have our gross profit (which is Revenue less COGS), our operating profit (gross profit less operating expenses), and then our bottom-line net income (operating profit plus any other income less any other expenses).
Nolan Batalha 1:08
As a bonus, we also have our contribution margin. This is an important metric for investors, so it’s key to understand what it represents: contribution margin is just our total revenue less our variable costs. When we talk about margin ratios, we are looking at these terms divided by our total revenue. So, gross margin is gross profit divided by total revenue; operating margin is operating profit divided by total revenue; profit margin is net income divided by total revenue. I hope you guys are understanding the pattern here! Contribution margin ratio is just contribution margin divided by total revenue.
Nolan Batalha 1:53
Let’s look at an example here. Here is Company XYZ’s income statement, and you can see that we have calculated our gross margin, operating margin, and profit margin. Our gross margin of 34% is simply gross profit divided by total income; our operating margin of 8% is net operating income divided by total revenue; and our profit margin is net income divided by total revenue—very simple stuff. Another important metric to analyze here is margin per revenue line. In this case, we have three revenue lines: food, beverage, and merch. Calculating the margin for each line item: for food, we have COGS of $80,000 and revenue of $100,000, which leaves us with a margin of 20%; beverage is 50%, and merchandise is 80%.
Nolan Batalha 3:00
Switching to markup: markup is how much extra we are charging for a specific item as compared to COGS. It can be represented as a dollar amount or a percentage. Unlike margin, with markup we are looking at the selling price versus the purchase price or direct cost. In a retail environment, we use purchase price; in a manufacturing environment, we need to understand our item direct cost—the cost of materials, labor, and manufacturing attributable to producing one extra item. As a calculation, dollar markup is simply selling price less item cost. As a percentage, it’s the profit (the dollar markup) divided by COGS.
Nolan Batalha 3:54
Let’s take a look at an example. In this example, we are looking at the same Company XYZ with the same revenue and COGS lines. To calculate markup, we first calculate how much extra we are charging for each line item. For food, our cost is $80,000 and our revenue is $100,000, so our markup is $20,000 (calculated by subtracting cost from revenue). To calculate the markup percentage, we take that $20,000 and divide it by our total COGS ($80,000), which gives us 25%.
Nolan Batalha 4:34
I hope these examples really illustrate the difference between margin versus markup. Again, margin is the measure of our profit as it relates to revenue, and markup is a measure of our profit as it relates to COGS. Again, my name is Nolan. Thank you!