Finance

Do The Math
Margin vs. Mark-Up

With MARGIN, you are
looking for the
Percentage of SELLING PRICE

                 Selling Price - Costs
MARGIN = ________________
                        Selling Price

With MARK-UP, you are looking for the 
Percentage of COSTS

                  Selling Price - Costs
MARK-UP= ________________
                             Costs

Here's the problem --

If you are targeting a 12% overhead MARGIN ($0.12 of every dollar goes to cover overhead) and a 10% profit MARGIN ($0.10 of every dollar goes to profit) but are using the MARK-UP calculation to create your estimate, you are going to miss your target.

Example:

A framing package costs $20,000. 

You charge the client 12% of $20,000, or $2,400, to cover overhead.

You charge the client 10% of $20,000, or $2,000, to cover profit.

The client is charged $20,000 + $2,400 + $2,000 = $24,400.*

Problem:

You are not getting a 22% (12%+10%) MARGIN.

Your total sale is $24,400, of which $20,000 is cost and $4,400 is MARGIN.

To calculate the MARGIN percentage, divide the $4,400 by the total sale of $24,400, and you get 18% MARGIN. You have left 4% on the table.

Result:

The correct calculation for MARGIN is Cost/(1-Margin percent).

For this example that would be:
$20,000/(1-22%), or $20,000/78% = $25,641, or a margin of $5,641.

The amount of money you left on the table is $5,641 - $4,400 = $1,241.

That's for a $20,000 framing package.  If the total direct cost of building the house is $400,000, and you use the MARK-UP calculation, you've left about $25,000 in margin on the table.

If you build 8 houses a year at that $400,000 price, you've left $200,000 on the table.

Conclusion:

This is not a small problem.

*We generally suggest calculating the profit on the cost + overhead + supervision + contingency, but have simplified the calculation for this example.

To find Selling Price (SP)
At a given MARGIN (M)
When Cost (C) is known

C/(1-M%) = SP

Cost is $2,500
MARGIN Desired is 30%

Selling Price is
2,500/(1-.30) = $3,571

To find Selling Price (SP)
At a given MARK-UP (MU)
When Cost (C) is known

(1 + MU%) x C = SP

Cost is $2,500
MARK-UP desired is 30%

Selling Price is
(1+.30) x 2,500 = $3,250

MARGIN to MARK-UP  Equivalents

MARGIN
50%
40%
33%
30%
25%
22%
20%
18%
15%
12.5%
12.0%
10.0%
5.0%
2.5%
0%

MARK-UP
100%
66.7%
50%
42.8%
33%
28.2%
25%
22%
17.6%
14.3%
13.7%
11.1%
5.26%
2.56%
0%

An example -- 

For example:  a 22% percent MARGIN requires a 28.2% MARK-UP

MARGIN Calculation $1,000 cost/(1-22% Margin) = $1,282.05

MARK-UP Calculation $1,000 cost + (1,000 x 28.2%) = 1,282.00

In my experience, clients are comfortable with the "12% Overhead, 10% Profit" pricing model. But make sure that you are using the Margin calculation to compute the end cost to your client.

If you are using a formula like "cost +22% Overhead and Profit MARK-UP" to build your estimates, it is costing you a lot of money.  You need to change to the MARGIN formula (Cost/(1-22%)) right away.

A great way to do that is to take a look at EstimatorPro, an estimating program that is properly configured to provide the right numbers. You can read what I have to say about EstimatorPro here, or go to the EstimatorPro website here.

Source: Sal Alfano, executive editor at Professional Remodeler



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