If you read the two previous blog posts (Markup vs Margin and Using Gross Margin Correctly), you understand how markup works and how gross margin works.
Are markup and margin interchangeable? Is a 1.55 markup the same as a 55% gross margin? No, here are a few examples using a job cost of $100.
Example 1:
Using a markup of 1.55 will give you a sales price of $155. ($100 x 1.55 = $155)
Using a margin of 55% will give you a sales price of $222. ($100 / .45 = $222)
Example 2:
Using a markup of 1.35 will give you a sales price of $135 ($100 x 1.35 = $135)
Using a margin of 35% will give you a sales price of $154 ($100 / .65 = $154)
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Remember that when using gross margin to calculate your sales price, you have to subtract your gross margin from 1, and divide your job costs by that figure. If your gross margin is 55%, subtract .55 from 1 to get .45, then divide your job costs by .45. This was covered in yesterday’s blog post.
What if you want a 30% gross margin on the sale? If you mistakenly believe you can get that by multiplying your job cost of $100 by 1.30, you’ll get a sales price of $130. Using gross margin properly, divide $100 by .70, and you’ll get the correct sales price of $143.
The difference is huge, and using the numbers wrong can cost you a lot of money.
So which should you use? It doesn’t matter AS LONG AS you use it correctly. In my opinion, markup is easier to use. It is almost always easier to multiply than to divide, especially when you are with a potential client attempting to make some quick mental calculations.
Let’s say you’re on a sales call, looking at a job, mentally trying to ballpark the price . . .
Using markup – “The job cost will probably be about $30,000, my markup is 1.60, that’s 6 x 3 or $18,000 added to $30,000, the job will probably run about $48,000.”
Using the equivalent gross margin – “The job cost will probably be about $30,000, my gross margin is about 38%, round it to 40%, that’s 4 x 3 = 12 or $12,000 added to $30,000, the job will probably run about $42,000. Wait! If it’s 40% I have to divide the job cost by .60, 30,000 divided by .60 . . . . “
Get the idea?
I’m a firm believer in keeping things simple. Gross margin works and will give you the correct sales price, but you’re more apt to make a calculation mistake and that mistake can cost you money. In my opinion – use your Markup and Profit, or use your Margin and Lose.
On a scale of 1 to 10, with 1 being the easiest method to compute the sales price of your service or work, markup is easily a “1”. Using gross margin is at least a “6”, which is why I think it should be avoided. Let your bookkeeper and your CPA wrestle with the math and computing margins, etc. You’re not in business to do math problems. You are in business to provide a service to your customers and make a profit doing it.
Calculate your corrent markup; the one that provides the sales price that covers your job costs, overhead expenses, and makes a reasonable net profit. Know how to use it, then focus your energy on selling your work. Stay focused on sales, that’s what you need to succeed..
Part 1 – Markup vs Margin
Part 2 – Using Gross Margin Correctly
The knowledge and experience Michael Stone gained in his 60+ years in construction has helped thousands of contractors improve their businesses and their lives. He is the author of the books Markup & Profit Revisited, Profitable Sales, and Estimating Construction Profitably, and is available for one-on-one consultations.