Business and Personal Finance: Know Your Costs to Set Your Prices

More Ways Accounting Helps Your Business – Know Your Costs to Set Your Prices

It seems like a simple fact: to earn profits, your prices have to be higher than your costs. It stands to reason that if you just add some percentage to your costs, your company will profit. With product-based businesses, set- ting prices starts with a markup on the product costs; service businesses can start with a markup of an hourly rate (either for employees or owners). 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. How- ever, not knowing the true costs can result in underpricing products and services.

FACT

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 the middle.

Here’s what your price needs to cover: the immediate cost of what you’re selling, a portion of your selling and general expenses, and a reasonable profit left over for you. Include every component of 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), remember to add on the costs of benefits and employment taxes. Pull the selling and general expenses right off your statement of profit and loss; 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 rain boots.

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