Using Accounting Details to Develop Pricing Strategy

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.

Price Accounting

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.

Price Strategy

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.

Details to Examine in Partnership Financial Statements

The best partners in a business, like ingredients in a good meal, complement each other. They are not identical, but they are not entirely opposite, either. Your business partner should bring elements to the partnership that offset your weaknesses. Going into business with someone is a big commitment. Taking it seriously means carefully reflecting on what each person contributes to the partnership.

Great partnerships are forged, for example, when one person is effective at sales while another individual focuses on production and managing the finances. In addition, certain similarities are necessary to enjoy advantages from having a business partner. Most crucial among these is that successful partners communicate clearly about goals and working toward the common achievement of them.

The indispensable tool for evaluating a joint effort by partners on a growth trajectory is an accurate accounting of business results. Financial statements must be understood together by the partners. Among the areas to examine are the capital contributions and draws of each partner. In general, these should be proportional to ownership percentages. Partners will also compare the business income to hours worked by each of them. These should be in accordance with the design when the partnership was formed.

Both partners should have assurance from the business’s financial statements that profitability is unfolding as planned. Even more important is identifying areas for improvement when profits are disappointing. This triggers a renewed focus on either sales or cost controls. Action is usually necessary on both fronts, which means a coordinated effort by the partners.