Adding 20% does not give you a 20% margin
This is the most expensive small mistake in trade pricing, and it is expensive precisely because it is small. It does not lose you a job. It quietly takes a few per cent off every job you ever price, and it never announces itself.
Markup and margin are both the profit as a percentage. They are measured against different numbers. Markup is profit over cost, so it is what you add on.Margin is profit over price, so it is what you keep. Same profit, different denominator.
So if a job costs you £100 and you want to keep 20%, adding 20% gives £120, and £20 on £120 is a 16.7% margin. To actually keep 20% you divide by 0.8 and charge £125. Five pounds a hundred, on everything, forever.
The rule worth memorising: to hit a margin you divide, to apply a markup you multiply. If you find yourself multiplying and thinking about margin, stop.
A few landmarks
- 25% markup is a 20% margin
- 33% markup is a 25% margin
- 50% markup is a 33% margin
- 100% markup is a 50% margin
The gap widens as the numbers grow, and that is how it goes unnoticed at the bottom end. At 5% it barely matters. At 50% it is a third of your money.
The true price of a discount
A discount changes how people negotiate. It comes off the price, and it comes out of the profit. The price is the big number and the profit is the small one, so a small-sounding discount is an enormous proportion of what you were going to make.
On a 12% margin, knocking 10% off removes about 83% of the profit. Not ten per cent of it. Eighty-three. To earn the same money you would need about six times the work, and six times the work is not sitting there waiting.
And the hard limit: a discount equal to your margin takes the price back to cost. Not most of the profit, all of it. If you work on 20% and somebody asks for 20% off, they are asking you to do the entire job for nothing. That is worth knowing before you answer rather than after.
Keep the tax out of it
Whatever your market calls it, VAT, GST or sales tax, it is not yours. You are collecting it and passing it on, and folding it into a markup or a margin inflates every figure you look at and flatters a job that is not performing.
Work the margin on the net price and add the tax at the end. The tool does it that way and shows the gross separately, so the number you are judging the job on is the number you keep. One related trap while you are here: taking tax back off a gross figure is a division, not a subtraction. £120 including 20% tax is £100 net, not £96.
Common questions
What is the difference between markup and margin?
Both are the profit as a percentage, measured against different numbers. Markup is profit divided by cost, so it is what you add on. Margin is profit divided by price, so it is what you keep. A 50% markup is a 33.3% margin, and a 50% margin needs a 100% markup. They only agree at zero.
How do I price for a 20% margin?
Divide the cost by 0.8, not multiply by 1.2. A £100 cost priced for a 20% margin is £125. Adding 20% gives £120, and £20 on £120 is a 16.7% margin, so you are four percent short of what you meant on every single job.
Why does adding 20% not give me a 20% margin?
Because you added it to the cost and you are measuring it against the price, and the price is the bigger number. The profit is the same either way: it is the denominator that changes.
How much can I discount before I lose money?
Exactly your margin, and not a penny more. On a 20% margin a 20% discount takes the price back to cost and you do the job for nothing. That number is much smaller than most people assume, which is why "knock ten per cent off" is a serious request rather than a rounding.
How much does a 10% discount actually cost me?
It depends entirely on your margin, and the answer is usually shocking. On a 12% margin a 10% discount removes about 83% of the profit, because the discount comes off the price but out of the profit, and the profit is the small number. You would need roughly six times the work to earn the same.
Should VAT or sales tax be part of the calculation?
No. Tax you collect is not yours and never was, so folding it into a markup or margin inflates every figure. Work the margin on the net price and add the tax at the end. The tool keeps them apart deliberately.