Markup Vs. Gross Profit
Common business jargon can confuse new business owners, such as the difference between markup and gross profit. These terms are closely related since a business cannot typically earn a profit without a markup on products or services sold. Simply put, markup is the difference between the price paid for a product and the amount it is resold for, while gross profit is the same resale price minus the cost of the product and all other expenses of running the business.
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Markup
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Markup is defined as the amount added to the price paid that determines the final sales price of an item. For example, a landscaping business that purchased shrubs for $20 each and resells them to its customers for $40 places a $20 markup on the product. The practice of marking up products and services is standard in every business, since this is how profit is generated.
Gross Profit
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Gross profit is defined as the total amount of sales minus the cost of what has been sold. Using the landscaping example, the landscape company purchased the shrubs for $20 each and resold them to its clients for $40 each. On a basic level, this is a 100 percent gross profit -- the landscaper doubled his money; however, it is not true gross profit since it does not include all the costs of doing business.
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Calculating Gross Profit
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Calculating gross profit on an annual basis first requires a total of all monies invested in the business for the year. This includes not only the products purchased for resale, such as shrubs, but also all other expenses required to operate the business. For example, operating expenses for the landscaping company would include tools, office expenses and license fees, among others. The total amount of operating expenses is deducted from the total amount of revenue earned for the year to determine the annual gross profit.
Determining Markup
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Determining the markup on a product should be based on the industry standard for a particular product or service, in addition to the amount of overhead expenses of the business and overall profit goals. Before charging a customer $40 for the shrub, the owner of the landscape company must know what his competitors are charging for the same type of plant. Placing too much markup on a product can lead customers away from your business, while pricing it too low may shortchange your gross profit. In some cases, it's a matter of preference. Some business owners prefer to sell 10 items at $5 rather than five items at $10; the total dollar amount is $50 in each scenario -- the only difference is the number of items left on the shelf.
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