by Sian Williams
So you’ve taken the big step and decided starting your own business feel’s right for you. You know that this product or service many small business new-comers will research their competition and base their prices to be competitive in the market place. Any business is better than no business, Right? Hmmm you may want to rethink that strategy.
Small business failure can be widely attributed to this issue of mis-pricing.
At EASE Business Services we strongly recommend you spend some time getting the pricing right for your business before you even accept your first customer. The following guide lines may assist and with some basic steps to understand this process:
Step 1: Calculate your estimated variable costs for your product/service
Variable costs are all those costs directly related to the product/service you are selling, the more of your product/service you sell, the variable costs will increase at the same rate.
Let’s use the local hairdressing salon as an example – the variable costs will be hairdressers time for the style cut as well as the products used for hair services, ie shampoo, conditioner, foils, tints etc. etc.
For a plumber or electrician the variable costs include the materials used and any labour used to complete the work.
These costs will vary between each situation but if you can make a rough estimate of how you’re your variable costs are per sale this will give you your gross profit.
Example: For each sale of $100, the variable costs are $50 and therefore you a gross profit margin of 50%.
Step 2: Calculate your total fixed costs
Your fixed costs are the cost that will remain the same no matter what the level output you produce. This includes things like power, administration staff or even home office expenses.
If you can calculate an annual cost we suggest then dividing this by 12 to give you a monthly estimate of your fixed costs. When starting out we do a quick calculation based on a ball park guess.
Step 3: Calculate sales projections
Hopefully you have done your homework and have a fair idea of the number of sales you can produce on a monthly basis.
Step 4: Based on the above calculate price
So once we determine your costs based on a fair accurate estimate, we suggest referring to some benchmarks based on your industry. A really useful resource that is are the small business benchmarks provided by the ATO: http://www.ato.gov.au/Business/Small-business-benchmarks/
You may operateat a loss in the early days as you discover the nuances of a new business. However as you develop an understanding of your new venture, you will be able to adjust your costs and tweak your sales price to determine your break even points.
Calculate how much sales you must have to ‘Break Even’
At the risk of getting too complicated here let me briefly touch on this important Break Even point which every owner should understand of their business.
The break-even point is where your calculated sales will be sufficient to cover both your variable and fixed costs.
When you have worked out step 1 and 2 this should be fairly straight forward (even if only estimated figures).
If your gross profit margin (Variable Cost/Sales), Break-even point is when Gross profit is equal to your total fixed costs.
So say you estimate you will sell 100 widget at $100 per month, $10,000 in total. We worked out that the Gross profit margin is 50% so Gross profit will be $5,000. If your fixed costs are also estimated to be $5,000; 100 units = break-even point.
Once you understand your break-even point you know at what sales level you need to be operating to be profitable.
Team Ease are ready to answer questions you may have in regards to this and any other bookkeeping/account/tax/small business question, contact us today: email@example.com