Markup
The difference between a good or service's selling price and the cost.
What is Markup?
The markup, also known as price spread, is the difference between the selling price and the cost of a good or service.
It is commonly noted as a percentage over the cost. To pay operating expenses and turn a profit, it is added to the overall cost incurred by the producer of a good or service.
The producer's overall production and distribution costs include fixed and variable costs.
It can also be seen in retail contexts, where retailers increase the selling price of goods by a specified sum or percentage to make a profit.
The term "variable cost-plus pricing method" refers to a method whereby a retailer determines a selling price by adding a price spread to the total variable cost.
It is the difference between the market price and the price a customer pays for securities that a broker-dealer privately owns.
Since the dealers aren't necessarily obligated to inform customers about it, broker-dealers are permitted to profit from selling securities.
The dealer must disclose only the transaction fee. The small transaction charge is the only expense in the buyer's eyes when buying bonds.
Bond buyers would have to cover the dealer's markup on the spread if they attempted to sell the bonds right away on the open market or risk losing money. The onus is on the bond buyers to assess whether they are getting a fair offer.
NOTE
Markup is expressed as a percentage above the cost of the product.
Key Takeaways
- They are also known as price spreads.
- It is the difference between a good or service's selling price and the cost.
- It is the difference between the market price and the price a customer pays for securities that a broker-dealer privately owns.
- A markdown is a difference between the market's highest current bid price for a security and the lower price that a dealer charges a consumer.
- Because market makers may frequently secure better pricing than retail buyers, they are more prevalent.
- The gross margin percentage is the proportionate difference between the selling price and the profit.
Markup Formula and examples
As mentioned earlier, it is the difference between the selling and cost prices. We will now derive this mathematically.
The calculation formula is expressed as
Price Spread = sales price - unit cost
But usually, we calculate its percentage, which can be expressed as
Markup percentage = [(sales price - unit cost)/ unit cost] * 100
Example #1
For example, an XYZ company sells a product to the retailer at $8; This is the cost price. Now, the retailer adds $2 as his value and sells the product to the final consumer at $10. The price spread is the margin of $2 between the cost price and MRP.
Therefore, the price spread on the cost price is 25 % ( 2/8): and
The Price Spread on MRP is 20% (2/10)
Example #2
Suppose you own a company that manufactures soap bars. You received a large order for 100 soap bars. The cost per soap bar is $5. What price should you charge if you want to earn a 25% profit on the order?
- Total cost of order = $5 x 100 = $500
- Selling price: 25%
25% = (Selling Price – Total cost) / Total cost
25% = (Selling price - 500)/ 500
This gives the selling price of $625.
Therefore, for you to earn a 25% price spread, you need to charge the company $625.
Selling Price – Cost Price = Selling Price * Profit Margin
This gives,
Profit Margin = 1 – (1 /(markup +1))
Suppose, the price spread is 25%, then profit margin = 1 - (1/(0.25 + 1)) = 20%
Markups vs. Markdowns
In finance, a markdown is a difference between the market's highest current bid price for a security and the lower price that a dealer charges a consumer.
The spread is calculated by deducting the price on the inside market from the amount a dealer charges retail consumers. If the spread is negative, it is referred to as a markdown; if it is positive, it is referred to as a markup.
Because market makers may frequently secure better pricing than retail buyers, they are more prevalent.
Markdowns can nevertheless happen in certain circumstances. A bond issue, for instance, might have less demand than a dealer anticipated. As a result, they might be compelled to lower the price to sell off their stock in this situation.
There are many reasons a retailer can choose to mark down its products. For example, when selling seasonal goods, the shop could be eager to eliminate the previous season's products to make room for the new ones.
To do this, they might reduce prices, even if it results in a loss on the transaction.
Some manufacturers may release new product models annually or every few years; in this situation, they may give markdowns on earlier models rather than take the chance of being forced to hold onto the outmoded stock.
For example, iPhone rates fall as soon as Apple introduces a new model.
Markup vs. Margin
These two concepts are increasingly being used interchangeably. Profit is different from markup!
The bottom line can be significantly affected by having a comprehensive understanding of the two and using them inside a pricing strategy.
In terms of terminology, the price spread percentage is the proportionate difference between the selling price and the real cost. In contrast, the gross margin percentage is the proportionate difference between the selling price and the profit.
Gross margin = Gross Profit/Sales Price
For example, suppose a product costs $150; the selling price with a 20% price spread would be $180:
Now,
Gross Profit Margin = Sales Price – Unit Cost
= $180 – $150 = $30
Markup percentage = Gross Profit Margin/Unit Cost
= $30/$150 = 20%
And,
Gross Margin Percentage = Gross Profit/Sales Price = $30/$180 = 16.66%
We can see the difference between the gross margin and price spread percentage!
For example, a 20% price spread produces a gross margin percentage of only 16.66% and not 20%, a common mistake many traders make.
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