Most electrical systems contractors (ESC) can tell me right off the bat what their markups are for equipment. They live and die by markups. At the same time, everyone complains that margins are falling—it’s harder to sell products and services to obtain a high enough margin to cover overhead and profit. All these statements are true—but does your Profit and Loss (P&L) statement tell you what margins you need? What markups you should charge?
Don’t confuse margin with markup
Many ESCs understand the difference between margin and markup. But many other small business owners continue to confuse the two numbers. I’ve spoken with many ESCs who look at their P&L and incorrectly interpret margin numbers to use as a markup.
The key is to remember that margin is always represented as a percentage of revenue; markup is always represented as a percentage of costs. If you charge the customer $120 for something that costs you $78, then you make a $42 gross profit. That means that $42 is left over to pay your overhead and leave some profit. The margin is determined by taking the gross profit ($42) and dividing by the sales ($120) to achieve 35 percent. Gross profit refers to dollars; gross margin refers to percentages. Therefore, in the above transaction, you earned a 35 percent gross margin.
$120 - $78 = $42 $42 ÷ $120 = 35%
The markup is determined by taking the gross profit ($42) and, instead of dividing by it by the sales, divide it by the costs ($78). Therefore, the markup is 54 percent.
$42 ÷ $78 = 54%
“Sure”, you say, “I knew that!” The mistake comes when you use a margin number as a markup. If you print out a P&L, it typically provides only margin numbers. It represents all costs as a percentage of sales. So if you sold 100 of those items and created a P&L, it will look like this:
Profit & Loss Statement
Sales 120,000 100.0%
COGS 78,000
Gross Profit 42,000 35.0%
Overhead 30,000 25.0%
Net Profit 12,000 10.0%
In fact, if you ask your accountant what your overhead and profit is, he or she might just tell you that it is 25 percent and 10 percent respectively. But that’s 35 percent of your sales (not of your costs). Remember, your sales figure should always be significantly larger than your cost figure. What happens if you use that number the next time you create a proposal? If you have a job that includes the same $78 of equipment, you might be tempted to mark it up by 35 percent (25 percent for overhead and 10 percent for profit). The result is that you will only charge $105 for that same product. And your financial statement would then look like this:
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