Margin

What it means

Margin is the difference between price and cost, usually expressed as a percentage of the price. Trade margin works from the purchase cost of goods, gross margin from direct costs, operating margin from overheads as well.

Margin and mark-up are not the same. A 50 % mark-up on cost is roughly a 33 % margin on the selling price - confusing the two is the most common pricing error there is.

A closely related concept is the contribution margin: price minus variable costs. Unlike the operating margin, it does not depend on how overheads were allocated, so it shows better whether another order is worth taking once fixed costs are already covered. Margin speaks about profitability, contribution margin about a decision.

How it works in practice

Margin is never watched only in aggregate. What matters is the split by product, channel or customer that sub-accounts provide: a company with a healthy average can be selling a third of its range below cost.

In a webshop the calculation includes gateway fees, shipping and returns; in services, non-billable time. Without them the number flatters - which is exactly what unit economics is about.

For construction and trades businesses we track margin by job: materials, subcontractor work and the hours of the firm’s own people are assigned to the job number when they are booked. At the end it is clear which job made money and which merely moved cash around, something the company’s overall result does not reveal.

What to watch out for

Growing turnover on a falling margin adds risk, not profit: more money tied up, more work, the same or less at the end. So a discount is always converted into how much volume must rise to pay for it.

Margin must be calculated from prices excluding VAT. If a selling price including tax is compared with a purchase price without it, the margin looks higher by the tax rate and the price list rests on a number that does not exist. With second-hand goods there is also the margin scheme, where VAT is charged only on the difference between selling and purchase price, and commercial and tax margins are easily mixed up.