Updated January 1, 1 . AmFam Team
The primary reason you started a business was to turn a profit, right? Of course. But in order to make money, it’s critical that you understand your service cost and its effect on pricing. If you’re a startup or an established business updating your pricing strategy, here are some tips on how to analyze the cost of your products or services to maximize profit.
“It’s really important for businesses, especially in their early stages, to focus on profitability and know their cost structure,” says Marie Driscoll, CFA at Driscoll Advisors (Opens in a new tab). “You can’t just follow your dream. You also have to look at the nuts and bolts of the business.”
Driscoll and Dominique Broadway, CEO and personal finance coach at Finances Demystified (Opens in a new tab), provide these steps to help you calculate your net cost per sale.
Step 1: Calculate total cost. Add up all costs incurred to produce the product or service – materials; labor; salaries and benefits; and overhead costs (both fixed and variable) such as rent, marketing, website maintenance, shipping, etc.
The goal is to make a profit, but you also want to ensure that you can cover your operating expenses, says Driscoll. Small business owners often fail to take into account items such as marketing, loans and money for expansion. That can all affect the price point you decide on.
“The easiest way to keep track of your expenses is to keep a spreadsheet and update it weekly,” says Driscoll. “There are plenty of templates both free and at a cost that you can use. Check out SCORE (Opens in a new tab) for a free version.”
Step 2: Calculate total sales. Total sales are your unit price times the amount of units sold. For example, if you charge $10 for a widget and sold 5,000 widgets, your total sales is $50,000 ($10 X 5,000 widgets).
Step 3: Divide your total cost by total sales. This is your net cost per sale. After calculating your net cost per sale you’ll be able to determine if you are pricing your products or services for profitability or if you’ll need to adjust the sell price based on your cost.
Conduct market research: “Shop around and see if there is anyone else that offers the same materials at a cheaper cost, but without sacrificing quality,” Broadway suggests.
Reduce marketing spend: Marketing and advertising often take up a large portion of a businesses’ budget. If that’s the case, Driscoll says, “use social media and other low-cost marketing and advertising options until you have the revenue to hire a marketing and/or sales team.”
Raise your prices: “If you can’t reduce your cost or find the materials you need at a lower rate, you may have to increase your prices,” Broadway says. But before you raise your prices, check out your competitors. “See what other people are charging so that you don’t price yourself out,” she adds.
Reduce staff: “For seasoned businesses, when sales start to flounder you can cut back by removing staff that are a part of your overhead expenses, “Driscoll recommends.
Don’t just get into business with a goal to break even, strive to be profitable and prosperous. “Anytime you are about to sell a new item, you need to determine the exact net cost of that item before you start pricing it to sell to the public,” Broadway says.