An early decision in the development of a business is determining how to price what’s being sold. The right price assures profit. A price that’s too high could cause consumer demand to evaporate. A price that’s too low will leave you bankrupt from expenses exceeding revenue.
Settling on an optimal price is the by-product of an accounting process rather than a guessing game. The exercise begins with a general operating budget. Assess your productive resources. This includes time because you can only work a limited number of hours per month. Determine how much can be produced with the given amount of time, personnel and equipment at your disposal.
Next, identify the average monthly costs for these resources. Some expenses are fixed, such as rent, Internet service and telephone charges. Other costs are variable, such as outside contractors and owner compensation. For these, assume maximum cash outflow when the business is operating at full capacity.
The sum of all ongoing expenses shows how much income is needed to break even. The last step is identifying a break-even price for your production output. If your business provides a service, for example, the price for a month-long project must cover one month of costs. A business that makes a product determines break-even price by dividing the number of units that can be made in a month into the monthly costs.
Knowing a break-even price is only a starting point. A small business typically tests various pricing strategies. This may entail charging a break-even price based on less than maximum output to gain a profit later when volume rises. A common pricing strategy is simply calculating all expenses and adding some profit. Then determine a price by dividing that figure by production output, whether that’s a typical project, a product or an hourly rate.
Of course, if you sell a common commodity or branded goods, your price is largely determined by the competition. This demand for competitive pricing means going back to your costs for assurance that profitability is viable based on market price. On the other hand, if your business can distinguish itself from competitors, careful price planning yields profit opportunities. This situation permits your enterprise to charge higher prices for greater quality even if it has a lower quantity of output.
Selling multiple types of services or products can complicate pricing strategy. If you want to explore item-specific pricing, you’re tasked with determining the costs for each thing your business sells. This means knowing the direct costs of providing each sale item plus allocating fixed costs among the various sales categories.
In most of the cases, however, a small business simply identifies an average price per product or service. Some things may sell for a higher price than their costs while others sell for slightly less than their costs. Nevertheless, identifying an average price for somewhat similar items or projects greatly simplifies pricing strategy analysis. The goal, of course, is for the average price of each thing sold multiplied by the number of sales in a period to cover costs for the period and provide some profit.