Markup vs. Margin Margin is the amount of gross profit, net profit, or overhead, compared to volume of work. (Expressed as a percentages) Markup is the amount you need to increase your price, or work estimates, to pay for the COGS, Over-head expenses, and receive a desired Net Profit Markup multipliers are what should be used for pricing but often margins are used.

Using Markups for Pricing Markups are used to establish prices, bids, estimates,… Such things as: Retail price of an item Bid or estimate of an entire job Amount to charge for an hourly rate of labor Amount to charge for an hourly rate of equipment.

Price must include: GOCS – Cost of Goods Sold Overhead Expenses Net Profit

COGS – Cost of Goods Sold Called Direct Expenses – Anything that can be directly invoiced to the job. Or, which is the direct cost of an item. Includes: Materials; Cost of the item, and other direct costs like delivery fees, sales tax, … Labor; Hourly rate plus labor burden; Fica, Futa, Suta, paid leave, Health Insurance, … Equipment rentals (for specific jobs)

Overhead Two categories of Overhead – Indirect and General Administrative Indirect costs would include such things as: – Fuel for trucks – Insurance for vehicles and equipment – Maintenance of equipment – Small tools – Drive time – And many, more – Sometimes these are included in direct costs

Overhead – General Administrative Office Labor and supplies Sales Labor Professional services Advertising Insurance Utilities Property and other taxes And many more.

Overhead For the purpose of this discussion overhead will include both categories; indirect cost and general administrative Some companies may deal with these seperately

Net Profit – or Real Profit -What is left after everything else is paid -Including payment of Owners salaries -Should be at least 5-10% -Usually available in the form of assets

Three Percentages to Remember Gross Margin, also called Gross Profit Margin Calculated by dividing Gross Profit by Volume* (Gross Profit/Volume)abrev. GPM Overhead Margin, as a percent of volume Calculated by dividing Overhead by Volume (Overhead/Volume)abrev. OHM Net Profit Margin Calculated by dividing Net Profit by Volume (Net Profit/Volume)abrev. NPM *also called Total Sales, Sales, and Revenue.

For Example In a company that has the following: Volume = $500,000 COGS = $298,000 Overhead = $170,000 Then it would have the following margins : Overhead Margin (OH/Volume): $170,000/$500,000 =.34 or 34% Net Profit (Volume – (GOCS + OH)): $500,000 – ($298,000 + $170,000) = $32,000 Net Profit Margin (NP/Volume): $32,000/$500,000 =.064 or 6.4%

Using Margins for Calculating Prices Remembering that pricing must recover COGS, OH, and Net Profit. (BTW – We recover the COGS by applying the correct OH & NP Margin) For a #7 Shadetree that costs (COGS) $48.50 (including Freight), you would: Multiply $48.50 X 1.34 (34%) for OH = $64.99 Multiply $64.99 X (6.4%)for NP = $69.99 for a selling price. Right?

Wrong!! Let’s check to see if we do indeed have it priced right to recover the needed margins Calculated price for the #7 Shade tree is $69.99 With an OH margin of 34% you would need $23.80 just to cover OH. (calculated by taking $69.99 X.34) If you subtract $23.80 from the $69.99 that leaves $ Which is not even enough to cover the $48.50 Cost. Not only is no Net Profit captured, there is a loss of $2.31; for a -0.5% net profit.

What Went Wrong Margins need to be calculated on the whole price of the item or service. Not as a percent markup on the cost (COGS). A ‘Markup’ multiplier is needed to create accurate prices. How??

The formula to calculate a Markup Mulitplier Markup Multiplier = 1/(1-(OHM* + NPM*)) *In decimal form Therefore, if you have an overhead that is 34% of your volume and you have a desired net profit of 6.4%, your markup multiplier would be; 1/(1-( )) = 1/(1-.404) = 1/.596 = 1.68 ( This gives you markup as a multiplier)

Markup Multiplier applied to COGS If an item cost $48.50 then it would be marked up 1.68 times or, $48.50 X 1.68 = $81.48

Now lets check the Margins With a price of $81.48 and an OH margin of 34% you have $27.70 for OH. Subtract that from the price ($ $27.70) equals $53.78 to cover COGS and NP Subtract the COGS ($48.50) from $53.78 and you have $5.28 in Net Profit. Or a NP Margin of 6.4%

Applying the multiplier to a bid If the direct costs of a job are estimated at $12,468 (materials, direct labor, other direct expenses); then it would be marked up 1.68 times or, $12,468 X 1.68 = $20,946.24

Or, to an hourly rate Hourly rate of $12.80/hour Plus $6.20/hour for labor burden Total of $19.00/hour $19.00 time 1.68 = $31.92/hour

Considerations of Variable Pricing With a correctly estimated price you can now apply variable pricing base on some of the following factors: – Size and type of job – Commercial vs. residential – Inventory considerations: turns, shrinkage, handling,… – DingDong factors – Bid specification complications – Need for work – Price barriers – Others

Another Example If overhead expenses are 28% And the desired net profit margin of 10% Then the Markup would = 1 /(1-(.28+.1)) which is 1.613