Pricing your products and services is one of the most challenging aspects of your business, get it right and you make a profit, get it wrong……..
The 3 main components of pricing are:
1. COGS (Cost of Goods Sold)- materials, labor, shipping, and other DIRECT costs.
2. Overhead Expense (FIXED costs)- rent, insurance, advertising, admin salaries, etc.
3. Profit- Your Return On Investment
COGS- these are your costs directly associated with the production of your product including materials and labor. If your accounting system is set up correctly you should be able to track your material costs fairly accurately for each product/order that you produce. Labor, on the other hand, is a bit more difficult and usually is rarely tracked correctly. Time studies are helpful to collect the actual time it takes to produce, deliver, and install (if applicable) your product.
Labor burdens (the total cost of your labor) is another area that can cause (incorrect) pricing of your product. You need to account for the cost of benefits (vacation, holidays, health insurance, workman’s compensation insurance, etc.), FICA, FUTA, and SUTA taxes that the company pays for. Just because you pay an employee $15 per hour doesn’t mean that they cost you $15 per hour, in all likelihood they are costing you close to $18.50 per hour! That’s an added expense to you of $7,000 per year! Multiply that by the number of employees you have and it adds up fast.
Overhead (FIXED)- expenses are difficult to price into your product or service (you can’t do it all on one order), so I suggest the following. Determine your annual COGS and overhead expenses for the coming year and use a ratio of FIXED/COGS for the overhead cost component of your product. For example, assume that your annual FIXED expense is $100,000, and based on the sales forecast for the year your COGS is determined to be $200,000. The ratio ($100,000/$200,000) is 0.5, which means for every $1 in COGS you need to add $.50 to cover your FIXED expense.
PROFIT- something every business needs if they are going to stay in business for the long term! Generally (net) profit margins vary by industry so a little research here is warranted, but in most cases a 5-20% NP margin is within the realm of realty.
To ensure you achieve the correct profit margin use the following formula:
(COGS + OVERHEAD)/1 – (NP MARGIN)
Once you determine what your pricing level needs to be you need to compare it to the market (and your competitors). Generally the calculated pricing will be higher than the market price, it is then up to you to decide if you need to raise your prices, cut costs, or increase sales.
I use a pretty sophisticated excel workbook that I have developed and use to help set the pricing for my clients’ products and services, I can help you determine your pricing level too.
"To your health, wealth and happiness, I'm the Cash Flow Doctor, and I make house calls"