Gross margin: how to calculate it
Markup, margin rate, multiplier: three often-confused notions that directly affect your prices and your profit.
Gross margin is the first profitability indicator for a trading or distribution business. It measures what is left after paying for what you sell. It is this margin that covers all your other costs — rent, salaries, transport, overheads — and generates a profit.
The basic formula
At company level, over a period: Gross margin = Sales of goods − Cost of goods sold, the latter taking inventory changes into account (purchases + opening stock − closing stock).
Markup or margin rate?
These two ratios are often confused, yet they are not calculated on the same base.
| Indicator | Formula | It answers the question… |
|---|---|---|
| Markup | Margin ÷ Purchase cost × 100 | How much do I earn relative to what I paid? |
| Margin rate | Margin ÷ Selling price × 100 | What share of my selling price is margin? |
| Price multiplier | Selling price ÷ Purchase cost | By how much do I multiply my cost to set my price? |
An example
You buy an item for MAD 1,000 excl. VAT and resell it for MAD 1,500 excl. VAT.
- Margin: 1,500 − 1,000 = MAD 500
- Markup: 500 ÷ 1,000 = 50%
- Margin rate: 500 ÷ 1,500 = 33.3%
- Multiplier: 1,500 ÷ 1,000 = 1.5
Same transaction, two very different percentages. When you talk about a "30% margin" with a partner, supplier or banker, always specify which ratio you mean.
Setting a price from a target margin rate
If you are aiming for a 40% margin rate on a product bought for MAD 600:
The classic mistake is to add 40% to the cost (600 × 1.40 = MAD 840): you then get a margin rate of only 28.6%.
The effect of discounts
A 10% discount on the selling price does not reduce the margin by 10%. In our example, the price falls to MAD 1,350 and the margin to MAD 350: it drops by 30%. To keep the same total margin, you would need to sell about 43% more volume. Discounts should be decided with a calculator in hand.
Trading margin or gross margin?
Trading margin applies to buying and reselling. For a manufacturing or service business, we talk rather about gross margin or contribution margin, including materials consumed, subcontracting or time spent. The reasoning remains the same: know precisely what what you sell costs you.
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