It’s always a little disconcerting when you get your mark up and margins confused or the wrong way round, as this can have a catastrophic effect upon the business taking it from profit to loss, and the risk of stopping after running out of cash. Yet how are we expected to know about these things? And where did we get taught about it?
The honest answer to this is we didn’t, so more often than not, new entrepreneurs are fumbling about in the dark trying to develop their price list and costing model. Watch any episode of Dragons Den and you will see at least one of the applicants wilt from the pressure of the Dragons over “what’s your margin?” or “how much do you make per unit?”. Often that answer is “it depends” but in their unsettling world, that’s a rubbish answer indicating you don’t deserve any money or the business should be stolen from you in percentage stake terms for the same amount.
So what are we talking about when we discuss margin and mark up? The key to making profit is to buy well – fail to do this and you already start at a disadvantage – but from that point on we need to add on any other purchased items that go into the product and mark them up, to arrive at the sales price.
For some, profit is a bit of a dirty word but it’s a vital one of you want to stay in business. It’s gross profit that pays the overheads and net profit that provides working capital and the ability to buy fixed assets, so without it you become a business failure statistic whether it be Carillion or the local shopkeeper who turns his sign to closed for the last time.
However, many of us confuse mark up with margin. Knowing that gross profit should be 50% some add 50% onto the costs of bringing the goods to sale. That means that if your total costs are £100, they make the selling price £150. That produces a margin of £50 per unit which is 33.3% gross profit instead of the £100 it should be. The sales price will be good so work will probably flow in – you get busy very quickly but you don’t make enough money to pay the overheads, including salary for yourself, in full or make breakeven at best.
It therefore follows that you end up making less salary to keep things going. Busy fool the description is for that.
To achieve a gross margin of 50% you have to mark up your costs by 100% thereby doubling them so our £100 becomes £200 sales value and the margin is 50% (100/200).
General trades businesses such as Plumbers and Electricians often provide subcontract labour and materials as part of their service. In these situations, they try to mark up these costs as much as they can to contribute to their sales price, but they also need to work out an hourly rate for their workers to be charged at. To do this you need to apply margin and do a calculation of reasonable hours on a weekly or daily basis that should get charged to identify if the expected sales value will cover all of the businesses overheads.
Need a little extra help? Come and join us for lunch and we can talk you through it…
These calculations are not necessarily difficult to understand, but not so easy to put across in a general article such as this. We run a Lunchtime Learning Session on this topic so if you are interested, please get in touch for a refresher. We generally provide sandwiches from the best shop in town for these sessions so you can enjoy a decent lunch on the house whilst sharing experiences with other traders in a similar situation.
If that isn’t Financial Mentoring at its best I am not sure what is, so please do let us know by getting in touch so we can run a session later in the year.
The views expressed in this article are the personal views of the Author and other professionals may express different views. They may not be the views of Lambert Chapman LLP. The material in the article cannot and should not be considered as exhaustive. Professional advice should be sought in connection with any of the issues contained in the article and the implementation of any actions.