It seems like a simple fact of business; to turn a profit your prices have to be higher than your costs. Is it really as simple as just adding some percentage to your costs to make your company profitable? Actually, it is. The hard part is determining your true costs.
With product-based businesses, setting prices starts with a markup on the product costs. Service businesses can start with a markup of an hourly rate, for the employees and/or owners providing the services to the clients. Those costs should be starting points, but many new business owners use these alone as a basis to set prices. For many new small-business owners, figuring out the complete costs of what they’re selling can be difficult. However, not knowing the true costs can result in underpricing products and services.
The price floor is the absolute minimum at which you can set your prices without sustaining losses on each sale. The price ceiling is the absolute maximum price the market will bear. The price you charge for your products or services will fall somewhere in between.
Here’s what your price needs to cover:
- The immediate cost of what you’re selling
- A portion of your selling and general expenses
- A reasonable profit left over for you
Include every component of your cost-of-goods-sold as you work the numbers for a product-based business. For a service business, use a reasonable hourly rate as your starting point; for yourself (if you’re not counted as an employee) and remember to add on the costs of benefits and employment taxes. Pull the selling and general expenses right off your profit and loss statement; if you have figures from two or three periods to work with, take an average. As for your desired net profits, add on a reasonable percentage for your industry. For example, someone selling original artwork could expect to see a higher profit percentage on each individual sale than could someone selling one-size-fits-all rubber noses.
