The Mysteries of Margins

Many people I come across are confused about the mysteries of margins that is gross margins, net margins and mark up!  So I thought I would set out the differences and explain their importance.

So let’s explain these mysteries.

Gross margins

The gross margin is the selling price of your product excluding VAT less the direct costs also excluding VAT.

For the purposes of this note, direct costs are the additional costs you incur when a product is sold.  So for example this would include the buying costs including freight, duty and transport where appropriate together with the selling costs of say postage and delivery.

If you sell something for a £ and your gross margin is 60% you get to keep 60p.  Out of this gross profit comes all your overheads that’s rent, advertising, employee costs and you’re then left with a net profit before tax or “before the tax man has his slice”.  This is known as the net margin.

Costs plus

Some businesses work on a cost plus basis so for example if the product costs you £100 and you mark it up by 20% the selling price again excluding VAT will be £120.  In this particular case though your gross margin will not be 20% but 20 divided by 120 = 16.7%.

Confusion

Confusion can therefore arise between a gross margin and a mark up and I have seen it happen.  The table below shows the difference between the two bases:

Item Gross margin at 20% Mark up at 20%
  £ £
Selling price 120 120
Direct cost 96 100
Gross profit 24 20
Gross margin 20% 16.7%

Significance

Businesses ought to know what they need to sell each month or year, say, before they make a net profit before tax.  This figure is known as breakeven turnover.

To work out your breakeven turnover you need to take the level of overheads and divide this figure by the gross margin.  If you’re working on a mark up of 20% and your overheads are £167,000 then your breakeven turnover will be £1,000,000.  If you’re operating on a gross margin of 20% with the same level of overheads then you breakeven turnover will be £835,000.  Quite a difference!

Assynt’s  role

Assynt Corporate Finance Limited does have experience in advising clients on how their direct costs and thus gross margins and gross profits can be calculated.  We can look at the classification of direct costs so that you can calculate accurately your breakeven turnover. If this is the case please contact Andrew Watkin on email: awatkin@assyntcf.co.uk or telephone: 07860 898452.

The information contained in this briefing is based on information available as at the date posted and may be subject to amendment.  It is written as a general guide and is not a substitute for professional advice.  You are strongly recommended to obtain specific professional advice from us before you take any action.  No responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this briefing can be accepted by Assynt Corporate Finance Limited  or its employees.

 

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