Definition of Gross Margin
Gross margin or gross profit is defined as net sales minus the cost of goods sold.
However, some people intend for the term gross margin to mean the gross margin as a percentage of sales (or percentage of selling price). Others will use the term gross margin ratio to mean the gross margin as percentage of sales or selling price.
Example of Gross Margin
If a retailer sells a product for $10, and its cost was $8, the gross profit or gross margin is $2.
The gross margin ratio is 20%, which is the gross profit or gross margin of $2 divided by the selling price of $10.
Definition of Markup
Markup in dollars is the difference between a product's cost and its selling price. [Note: some retailers may use the term markup to mean an additional markup from an earlier selling price.]
The markup is also expressed as a percentage of cost (not selling price).
Example of Markup
Assume that a product has a cost of $8 and the seller sets a selling price of $10. In dollars, the markup is $2 (the same as the $2 gross profit).
However, the markup is usually expressed as a percentage of the product's cost (not its selling price). Therefore, the $2 markup divided by the product's cost of $8 results in a markup that is 25% of cost.
Thus, if a retailer wants its income statement to show a gross profit that is 20% of sales, the retailer must mark up its products' costs by 25%.
