Understanding Margins and Markups, for Online Sellers

Understanding Margins and Markups, for Online Sellers

Before I dive into this, the first thing I want to disclose is that math was one of my worst subjects throughout school.  So I ran this article by my bookkeeper to get her input and any suggested corrections.  Nevertheless, I am sure a few of my readers are accountants or math wizards and may find fault with it.  Don’t hesitate to email me if you do.  I also want to caution you that I am no expert on taxes, so any tax issues you have I suggest you run them by a licensed and competent professional.

These subjects can be very complicated but what I have tried to do is simplify them and bring them down to a level where any seller can use them.  Having said that. I want to emphasize the importance of understanding at least the concepts, to help run your business.

Many sellers work hard to find inventory, sell it and all seems to be going well, yet at the end of the month they have more bills than cash.  Not understanding these concepts is a sure path to a failed business.  Lets look at each one of these one at a time –and when you understand each of them individually, you will quickly see how they come together and you will be on the path to understanding your business better, and avoiding mistakes that can really hurt your income.

  • Markup
  • Margin
  • ROI (Return on Investment)

Let’s start with markup.

Markup is the difference between the cost of a good (product) and its selling price.  The total cost reflects the total amount of both fixed and variable expenses (such as inbound shipping or shipping to Amazon FBA) to distribute and sell a product. Markup can be expressed either as a fixed amount, or as a percentage of the total cost or selling price. Retail markup is commonly calculated as the difference between wholesale price and retail price, as a percentage of wholesale.

Lets look at an example of markup.

You buy a product for $12 and sell it for $22.95.  The difference is $10.95.  If you divide your $10.95 net by your $12 cost then your markup is 91.25%.

There is another way to express this.  Let’s use very simple numbers.  You buy something for $10 and Sell it for $20.  That is a 100% markup.  If you sold it for $30, that would be a 200% markup.  (Each $10 represents 100% so adding $20 is 2 x or, 200%).

Margin

First of all there are several types of margins – Gross margin, net margin and profit margin.  Let me define these, but they are all essentially calculated the same way.

Gross margin – If an item costs $22 (including inbound shipping costs) and you sell it on Amazon for $44.95.  The difference is (44.95 – 22) =  $22.95.  That is your gross margin.  We are going to ignore shipping costs to the customer in these examples just to keep it simple, but know that the cost of packaging material and shipping is often an added cost you should consider.

Net Margin – So your gross margin is $22.95.  However, we all know that  Amazon charges fees.  Say your fees come to $5.35; you subtract those from your gross margin to get your net margin of $17.60.  To express this as a percentage you divide your net profit by your selling price (17.60 / 44.95) = 39.1%.  So your net margin on that sale is 39.1%

Profit Margin – Profit margin can refer to one sale.  If you are doing that you already know that it’s your net margin –or 39.1%.  But when business owners think of profit margin they are typically referring to their business in total – not one, or a few sales.  What you really want to know is:  What is your total net profit margin at the end of month, quarter or year?  The margin at the end of the year is critical to know, because that is what you will pay income tax on.

Lets just do one month to keep it simple, but the same method works to calculate your profit margin for a quarter or the entire year.

Profit margin is the total of the margin on all of your sales for the month less your cost of goods sold (again including inbound shipping), all fees to get at your net margin, then subtract all the expenses of running your business.  Here is an example:

Sales for the month $80000.00[1]
Total Cost of Goods Sold (COGS)  36000[2]
Gross margin $44000
Less eBay and/or Amazon fees – 12000
Net margin $32,000

Now let’s list our other business expenses for the month.  In business these expenses are called overhead.  Normally one of the big overhead items is labor, but lets leave that out and assume you are doing this all working from home.  But if you did have any hired help you would have to add that to the list as well. (We will assume for this example that all of your furniture, computers and so on are all paid for.  There is an accounting factor on these types of items, called depreciation, but I am going to ignore that in this example to keep it simple.

However, at tax time, you want to let your tax guy know how much you have invested in an automobile or computer during the year so he or she can calculate depreciation.

ISP, DSL Fees $62.00
Telephone 146.00
Office Supplies 145.50
Car expense related to business 98.75
Travel and meals related to business 738.55
Any advertising or promotions 125.55
Storage or mailbox rental 200.00
Interest expense 36.00
Insurance 185.00
Legal expenses & Bookkeeping 120.00
Professional dues and subscriptions 110.00]
Total $1,857.35

Subtract the $1,857.35 from your net margin and you will get your net profit which is what you will pay taxes on.

This is a very partial list of expenses.  Again to keep this simple, I have ignored things such as taxes collected and paid, depreciation, and other expenses you may run into.  To get an accurate idea of expenses, take a list of all your expenses to your tax preparer and ask him or her which ones you should be considering.

You don’t want to miss any because remember, the profit margin at the end of the year is what you are going to pay taxes on. If you are selling in this volume on Amazon, I am sure your expenses are going to be much higher than this.  For one thing to sell at that level you will probably have some help so you may have a few thousand in labor costs.

So our net margin  at the end of the month was $28,800.  When we subtract our monthly business expenses from that we get ($28,800 – 2207.35) = 26,592.65; Not bad !!!  If you want to know your profit margin for the month as a percentage just divide 26,592.65 by your gross sales of 80,000 and you get 33.24%.  If you could really do that, you are a brilliant businessperson.  But as I said, my expense list is very basic and your real expenses are most likely going to be somewhat higher.

Return on investment (ROI)

To find you ROI, first pick a period such as a quarter.  Now add up your Cost of Goods sold for that period (your investment)  and divide by the total net profit for the same period.  The resulting number is your return on Investment

[1] Sales would include money you collected for shipping to customers if any

[2] COGS would include the costs for shipping and packing materials and outbound shipping costs.

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2 Comments

  1. You didn’t cover ROI and cash flow

    1. Author

      Decided to do a separate post on those

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