Calculating markups and margins might sound easy, but the maths can get confusing quite quickly. In fact, I come across many business owners who think they understand how this works but are actually getting their calculations wrong. If your head hurts when you hear terms like ‘margins’ and ‘markups’, this blog is for you!
VAT-inclusive vs VAT-exclusive pricing
In business-to-business (B2B) transactions, discussing net costs and prices is a common practice. If your business delivers a service to another business, it wouldn’t occur to you to use the VAT-inclusive price. In retail, however, you are selling to individual customers, and they need to know the overall price they will pay because they cannot claim back the VAT. VAT is essentially hidden from the customer in a B2C setting, and many consumers might not even realise that VAT is chargeable on the item they are buying. But you must never forget it’s there!
As a business-to-consumer (B2C) retailer, you are dealing daily with two ways of calculating: when you’re talking to your suppliers, you’re discussing costs that are net of VAT, and when you’re setting prices for sale, you’re thinking of amounts that are inclusive of VAT. This isn’t intuitive and requires you to always be aware of whether you are looking at net or gross figures.
How to correctly calculate net price from a VAT-inclusive amount
Many people struggle with calculations that go from gross to net and net to gross. My first financial exercise for you as a retailer is to get used to thinking of your sales price calculation as being net of VAT (also known as VAT-exclusive). If an item is on the shelf for €100, that isn’t your real sales price! You must subtract the VAT first so that you are using the right figure.
A common mistake I see people make is calculating their net price by working backwards from the gross amount. So, they’ll work backwards from the total and take off the VAT rate:
INCORRECT
€100 x 23% = 23
€100 – €23 = €77
This is wrong because you’ve taken the total amount and applied 23%, but sales tax is always applied to the net amount. The correct calculation is:
CORRECT
€100 ÷ 1.23 = €81.30
The incorrect method produces an answer over 5% lower than the correct one – a difference of €4.30 on a single €100 item. Across an entire product range, that gap becomes significant.
If you are unsure about any gross-to-net calculation, check it by reversing the arithmetic:
€81.30 x 23% = €18.699 (round up to €18.70)
€81.30 + €18.70 = €100 ✓
Even with 25 years’ experience working in accounting and financial management, I still check my work by reversing the calculation. I recommend you do the same.
Markup vs margin in retail: key differences and how to use them
It can sound like these two terms are interchangeable and that you’re simply talking about the same thing. But these two concepts have entirely different uses and a different place in accounting. It’s important to understand how they are used when running financial calculations for your business. Markup is applied to the cost price; margin is expressed as a percentage of the selling price.
How to calculate your retail markup (and cover your business costs)
A markup should be used when you are talking about pricing. As a retailer, you buy in products at a certain price, then add an amount to it to arrive at your selling-on price. As an example, let’s say I buy shirts at €100 each and add a 100% markup. That means I will sell the shirt for €200 plus VAT at 23%:
€200 x 23% = €46
€200 + €46 = €246 final shelf price
Markup should be easy enough to work out, as you can see. You’re starting with a net product cost and only adding the VAT once you have included your markup percentage. Remember this markup has to account for all the costs of running the business if you are to be profitable – for example, utilities, staff, marketing and advertising, profit, etc.
How to calculate gross margin (and use cost of goods sold (COGS))
A margin should be used when you are talking about results. Margin is sometimes referred to as gross profit. Let’s say I’m looking at how the past week went for the shop. I know the shop pulled in €10,000 in sales (remember we’re not including VAT in these numbers because that is simply sales tax and not part of our revenue, so your till rolls will be giving you an amount of €12,300 and you need to find your net figure). If your total sales were €10,000 and the goods cost you €6,000 (again, net of VAT), then your margin was €4,000, which is 40%:
€10,000 – €6,000 = €4,000
€4,000 ÷ €10,000 x 100 = 40%
This gets more complicated when stock is bought and sold at different times. You may have purchased a batch of a particular product on 10th January – so there will be a cost to the business showing in the accounts that week – but it might take until 20th March before the items are all sold. In any given week, how do you apportion the cost of that purchase to the sales you have made?
This is where an accountant would look at your ‘cost of goods sold’ (COGS) rather than taking the lump sum cost of any supplier invoices you paid. It works as follows: I get a delivery, and I put the items into my stock or inventory figure. It’s now an asset that can be balanced against sales as they occur. This gives a clear margin figure when I look at the profit and loss account (P&L).
When I look at an inventory figure as an asset and take out whatever has been sold, I see a clear picture of what the inventory value should be. Tracking inventory this way does depend on carrying out periodic stocktakes to ensure the numbers remain accurate (month-end is a good time, as this also allows you to run your monthly management accounting report with confidence).
How trade discounts eat into your markup more than you think
Another area where I’ve seen people miscalculating the markup is when applying trade discounts. Let’s say you have regular walk-in customers plus trade customers. Trade customers expect a discount, so you offer them 20% off. The reason it trips people up is this: markup is applied to the cost price, whereas a discount is applied to the selling price; the two percentages are not directly comparable.
Here’s how this plays out on a product that costs €10, marked up by 100%:
| Standard customer | Trade customer (20% discount) | |
|---|---|---|
| Cost price | €10 | €10 |
| Markup | 100% (+€10) | 100% (+€10) |
| Net shelf price | €20 | €20 |
| Discount applied | – | 20% (-€4) |
| Net sale price | €20 | €16 |
| Gross profit | €10 | €6 |
| Effective markup | 100% | 60% |
It is tempting to assume that giving away 20% of the selling price leaves you with 80% of your original 100% markup, but this is faulty logic. In fact, you have given away 40% of it. The discount is calculated on the higher selling price, so each percentage point of discount has a greater effect on margin than the equivalent percentage point of markup.
How pricing errors can damage retail profitability
When I talk to smaller retailers, it’s not unusual for them to have confused markups and margins or to have folded VAT into their calculations. This means they are not making as much as they need to cover all their costs and salaries and still make a decent profit. I think this is a tragedy because retailers work so hard, and yet many don’t make any money and don’t survive very long. Upskilling on financial concepts and embracing an easy and consistent methodology for your pricing will help you avoid this problem.
Getting used to applying markups of 100% or more takes confidence, too. An experienced retailer knows that they must achieve this level of margin to pay for salaries, rent, and overheads while leaving a reasonable surplus at the end. It’s important that your business brings in sufficient cash to stay financially healthy. Even more so if you sell products that are seasonal or when confronting unforeseen market disruptions.
If you feel you are not as on top of this as you should be, don’t be afraid to ask for help. A lot of people assume these calculations are simple and won’t admit they are struggling, but as I hope this piece has shown, the errors are easy to make and the financial consequences are real. In my experience, asking the basic questions opens up some of the most productive conversations a business owner can have. So start those conversations now – with your partners, your staff, your accountant, and your peers.
