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.
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.