It’s not until you’re a business owner that you begin to reliase (in detail) why the price of your product can impact so many parts of your business.
Say you’re selling a milkshake…
Add up the cost of one cup of milk and a bit of chocolate syrup. If you’re lucky a scoop of ice-cream.
But wait! Add in rent, staff wages, electricity, the shop fit-out, insurances and the list goes on. Then on top of all those expenses they must pay income tax. What’s left over after all that is their profit?
As an accountant, I spend my days helping businesses make more money (in a way that’s right for them). And if a business comes to me struggling to make ends meet the first thing I do is review their pricing!
If you’re interested in pricing for a service-based business. Head over here. If you are running a product based business and want to start investigating your pricing, read below…
Product based business pricing
If you have product based business pricing (purposefully) can become a little tricky, but hang in there, because it’s going to be worth it!
The first step is to calculate the bare minimum you need to charge to cover the cost of the product, running costs of the business and taxes.
Read that sentence again guys, bare minimum, you need to be charging ABOVE this to be makin’ moolah, otherwise known as profit.
Grab your pen and paper.
++ Start with the cost of your product
If the product is imported, add in any shipping and importing charges or duties to the cost of the product. If you are manufacturing this product add up all the individual components – Every. Single. One!
You can get very specific here or work in multiples that you produce. So, if you work in lots of 10’s, 100’s or 1000’s, then work with that. For example, if you order 100 products and you need 100 mail bags to send them out from your online store, work out how much 100 mail bags cost you. This is your cost of product and all the direct costs associated with it.
++ Add in your running costs
This is the cost of the *magical* things that happen in the background to make your business run. Wages, websites, insurances, leases. All those items. If you’re unsure where to start adding these up, I highly recommend printing out your last few bank statements or tax return. Having a list (somewhere) of your monthly, quarterly and annual bills is so important. Include the amount you wish to pay yourself here.
The way to work out how much of these operating expenses relate to those specific products depends on your business. Some business know that they sell approximately 1000 products per year so they work out their operating expenses for a year – say $5000 and divide by 1000 products. This means $5 ($5000/1000 products) needs to be applied to each product to cover these expenses.
For business that don’t know how much they sell per year yet, work it out by sales for the month or week. Chunk it down till you have an average sales figure that you can use. Estimates here are fine.
As I mentioned before in running a business, there’s no hard and fast rules. You may need an alternative way to assign running costs to products if you have many different categories of items.
Each product may have different profit margins, sales volume or shelf life. This will impact how you plan to recoup these running costs. By profit margin I mean, some items cost $10 but you can sell for $100- this is high profit margin or mark up, others you need to sell for $15 and still cost $10. This is a much lower profit margin. You can assign more of these behind-the-scenes costs to those items which have high profit margins. Basically, it’s like going out to dinner with the king and a pauper, you’re going to hit the king up to pay most of the bill at the end of the meal!
Whichever way you choose to ‘cover’ these expenses, the idea is that between all that you sell- you have covered these running costs.
++ Add on income tax (and GST or any other tax imposed if you must pay it)
As with the service pricing example, head back here if you wish to read it, the last piece of the puzzle is tax. Make sure you add that 30% (or your relevant tax percent) on to your calculations.
To recap, we have:
- the direct cost of the products and any components directly related to making or sending it
- the costs of running everything in the background (your operating costs)
- adding on tax that will need to be paid
What’s listed above is just to cover COSTS. Your bare minimum cost of the product. Ensure your sale price for the item is above this figure. How much above you say? Well the sky is the limit….
And importantly- review your numbers as your business grows, as you take on more staff, machinery or products!
Just remember, it doesn’t matter how many products you sell; if you have priced your product too low, you’re bottom line will always struggle.