So I am trying to find out what the following method is called, that is used to calculate a dilution.
Soap makers would mix their main ingredient with a base product which dilutes the main ingredient. They would say something like "dilution 25%". This means that they would take 100ml of the base product and add 25ml of the main ingredient.
However, I would say the whole 125ml so the dilution is 31.25% or 68.75% percent depending on which way you are looking at it.
I think maybe dilution is the wrong word to be using, however does this have a name or logic?
Assuming, as per my comment above, that you really meant $20\%$, not $31.25\%$, then I understand your confusion. However, there is a good reason you would do it the way they do it: It's practical when you're actually making it.
Consider this: Say you make soap batches of many different sizes, but they all have the same proportions of ingredients: $20\%$ of the finished product is main ingredient, $80\%$ is base ingredient.
When you're writing a recipe, and especially if you're teaching assistants to help you, which would you find less confusing and prone to error? Which one is easiest to do quickly, in the head, on the fly, as you go about your daily routine in the soap factory?