In today’s short podcast, Bryan clears up the differences between markup and profit margins in HVAC businesses.
The number one mistake that people make in business is confusing markup and gross margin. For example, you can double the price of a $50-part and sell it for $100. That would be a 100% markup. However, your gross margin is NOT 100%; your gross margin is only 50%; you only made a 50% profit on the total sale.
In the same case you have above, you have a 50% cost of goods sold (COGS). COGS is the direct cost of the expenses you paid to sell your service or product. The opposite of COGS is overhead. Overhead includes anything that doesn’t directly bring money to your business (rent, utility bills, etc.). Let’s say that your overhead costs total $30. You’re left with $20 of net profit.
Typically, 10-20% net profit is a good (if slightly idealistic) goal. Net profit can contribute to business growth if you put it into your business. For example, you can use that money for advertising, buying vans, and buying better tools.
If you want to determine a 10-20% goal, DO NOT USE MARKUP. Instead, you need to divide by your COGS expenses. In the case of the $50-scenario, let’s say that our cost of goods sold is 60%, so that seems like a 40% markup. You would divide 50 by 0.6, and you would get $83.33. If you multiplied by markup (140% or 1.4), you would have gotten $70. You wouldn’t come close to your gross margin number using the markup method.
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