Once you know how much the merchandise or job costs, you mark it up to provide a profit. One way is to use what’s known as “keystone” pricing, which simply means doubling the cost to arrive at the selling price. This provides a 50% gross profit margin. That’s why retailers can put goods on sale for 40% off and still make a profit. It works fine, but it isn’t always the best choice.
You can also use manufacturers’ suggested retail pricing, which even further simplifies the calculations. Nationally uniform prices, of course don’t reflect local market conditions, much less the individual business owner’s costs of doing business. Remember, too, that they’re designed to help the manufacturer move more merchandise, not necessarily help you make more money.
Using a standard markup sounds simple, but that’s really only the beginning of sound pricing strategy. You also have to be sure that the gross profit is large enough to cover your overhead, or the indirect costs of operating your business, and still leave a net profit. Whether you’re marking up merchandise or deciding on a labor rate, you’ve got to build in something to cover the rent—and all those other bills you pay every month.
Every business has indirect expenses (not related to the cost of a piece of merchandise or a particular employee’s labor on a job) that have to be paid. The obvious ones include your building and what it costs to operate it (utilities, maintenance, taxes, insurance), your fixtures, tools, office equipment, vehicles and other fixed assets (their cost on an annual basis is your depreciation expense), your salary and benefits (especially health insurance), not to mention the office manager and other general employees. Don’t forget to add in your property and casualty and liability insurance premiums, accountant’s fees, advertising and marketing expenses, office supplies, telephone, and so on and so on. While you’re at it, make sure you include an annual contribution to your own retirement plan, be it a 401-K, SEP-IRA, or whatever.
Finally, add something for net profit. That’s the whole point of running the business, right? The net profit, by the way, is not the same as your salary as the manager or owner. Your salary is payment for your labor managing the business. If you’re the owner, the net profit is the return on your investment and the compensation your receive for the risks you take. There’s a big difference.
The total dollar amount of your shop’s gross profit, the figure that has to be larger than your overhead expense, is also dependant on how much merchandise you sell or how many jobs you complete. These are determined, at least in part, by the prices you charge. If your prices are too high, customers will run away, so it can be a vicious circle. Cost-based pricing is all well and good, but ultimately, the prices you charge are determined by what your customers are willing to pay. That’s where a whole raft of other factors comes into play.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
Showing posts with label financial management. Show all posts
Showing posts with label financial management. Show all posts
Monday, October 8, 2012
Monday, October 1, 2012
Pricing For Profit - Step One
When it comes to prices in your business, how much is enough and how much is too much? How do you set your prices? Buy low and sell high is the obvious answer, but for many companies, especially those with a mixture of retail merchandise and services, bricks-and-mortar and online competition, and customers driven one day by a penny-pinching budget and the next by the lust called gotta-have-whatever-at-any-price, there aren’t any easy answers.
Setting prices requires that even the most experienced manager or owner take a few moments every once in a while to dust off the calculator, get the accountant on the phone, and do some serious figuring. It’s tempting to just mark all merchandise up by a fixed percentage and figure labor at a flat rate comparable to what your competitors charge, but that’s not managing for profit, it’s hoping for one. There are several factors that you should consider.
Start with the cost of goods sold. That’s the amount you pay the manufacturer, wholesaler, or whomever for the merchandise you sell, whether at retail or as part of a service job. But it also includes the cost of acquiring those goods (shipping and handling), carrying them in inventory (interest expense), and allowances for returns and defective merchandise. If you pay any salespeople a commission or spiff, that needs to be taken into account, too.
For service work, you have to cover your direct labor costs on each job. These include not only an appropriate portion of your technicians’ annual salaries, but also their benefits, payroll taxes, unemployment insurance, worker’s compensation insurance, etc
What about the cost of your time? Whether you are a one-person business or simply provide indirect supervision of your staff, your time is a cost that has to be covered. One way to approach this is to divide what you expect to personally earn on an annual basis (including those items above but not your profit from the business—I’ll talk about that later) by 2,000, which is roughly the number of working hours during the year. Let’s say your “salary” plus benefits is $100,000. Your hourly labor cost is $50. Multiply that number by the hours you estimate you’ll personally spend on the job, add in the other worker’s costs, and you have your direct labor costs.
These aren't the only factors, so check next week for more guidelines on pricing for profit.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
Setting prices requires that even the most experienced manager or owner take a few moments every once in a while to dust off the calculator, get the accountant on the phone, and do some serious figuring. It’s tempting to just mark all merchandise up by a fixed percentage and figure labor at a flat rate comparable to what your competitors charge, but that’s not managing for profit, it’s hoping for one. There are several factors that you should consider.
Start with the cost of goods sold. That’s the amount you pay the manufacturer, wholesaler, or whomever for the merchandise you sell, whether at retail or as part of a service job. But it also includes the cost of acquiring those goods (shipping and handling), carrying them in inventory (interest expense), and allowances for returns and defective merchandise. If you pay any salespeople a commission or spiff, that needs to be taken into account, too.
For service work, you have to cover your direct labor costs on each job. These include not only an appropriate portion of your technicians’ annual salaries, but also their benefits, payroll taxes, unemployment insurance, worker’s compensation insurance, etc
What about the cost of your time? Whether you are a one-person business or simply provide indirect supervision of your staff, your time is a cost that has to be covered. One way to approach this is to divide what you expect to personally earn on an annual basis (including those items above but not your profit from the business—I’ll talk about that later) by 2,000, which is roughly the number of working hours during the year. Let’s say your “salary” plus benefits is $100,000. Your hourly labor cost is $50. Multiply that number by the hours you estimate you’ll personally spend on the job, add in the other worker’s costs, and you have your direct labor costs.
These aren't the only factors, so check next week for more guidelines on pricing for profit.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
Monday, September 19, 2011
Attention To Business Details
Ask anybody who spends their day in a furniture finishing spray booth, and they’ll tell you ninety percent of success in a paint job comes from attention to detail. Proper sanding, masking, tacking, priming, and so on are mandatory. So is a clean gun, properly mixed paint, and the right temperature in the spray booth. Skip a step or give it a half-baked effort, and you’re going to find sags, clouds, over-sprays, fisheyes, and other ugly features in your finish coat. Your attention to detail is what matters.
The same is true when it comes to running your business. Just as a perfectly-applied finish coat depends on what came before it, a successful business depends on dozens of factors other than the ability of the company to produce eye-popping work. Profit doesn’t just magically appear. It’s the result of constant attention to the large number of details involved in running a successful business. Unfortunately, like sanding between finish coats, most of these details aren’t things many people consider fun.
How much do you enjoy bookkeeping, for example? About as much as you like root canal, right? You know it has to be done, but you’d just as soon not do it yourself. I know plenty of company owners who approach the job of keeping their books by throwing all their receipts, invoices, and bank statements into a big box. When tax time rolls around, they dump the box on their accountant’s desk and wait for the bad news. This approach is about as effective as throwing an old sheet over a sofa and calling it re-upholstered.
As tedious as it is, keeping a timely set of books will help you run a company with much higher profits. And with the availability of easy-to-learn software, you don’t need to be a CPA to master the basics. Even if you’re lucky enough to have an office manager who handles the task, it’s a good idea to personally review the results every month. Good, timely bookkeeping will help you spot profit leaks before they become floods.
If you review your books in detail, you can plot the costs of materials or labor over time to see if there are any negative trends developing. You probably have a good sense of what’s happening, but it’s never a bad idea to have the specifics in front of you before you make any decisions. You can also spot cash flow glitches and accounts receivable problems before they occur so you can take the appropriate steps after considering all the alternatives. It’s always better to talk to your banker about a loan before you’re in crisis mode.
You may also have a nice surprise in store when tax time rolls around. If your accountant doesn’t have to wade through your box of dusty documents, he or she should charge you a lot less to prepare your tax return. And who knows? Your diligence throughout the year may actually enable you to lower your tax bill by shifting expenses or revenues—quite legitimately—from one year to the next, by making a timely retirement plan contribution, or by using other time-sensitive strategies of the tax-wise. You can only do those things if you’ve paid attention to the details of your bookkeeping.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
The same is true when it comes to running your business. Just as a perfectly-applied finish coat depends on what came before it, a successful business depends on dozens of factors other than the ability of the company to produce eye-popping work. Profit doesn’t just magically appear. It’s the result of constant attention to the large number of details involved in running a successful business. Unfortunately, like sanding between finish coats, most of these details aren’t things many people consider fun.
How much do you enjoy bookkeeping, for example? About as much as you like root canal, right? You know it has to be done, but you’d just as soon not do it yourself. I know plenty of company owners who approach the job of keeping their books by throwing all their receipts, invoices, and bank statements into a big box. When tax time rolls around, they dump the box on their accountant’s desk and wait for the bad news. This approach is about as effective as throwing an old sheet over a sofa and calling it re-upholstered.
As tedious as it is, keeping a timely set of books will help you run a company with much higher profits. And with the availability of easy-to-learn software, you don’t need to be a CPA to master the basics. Even if you’re lucky enough to have an office manager who handles the task, it’s a good idea to personally review the results every month. Good, timely bookkeeping will help you spot profit leaks before they become floods.
If you review your books in detail, you can plot the costs of materials or labor over time to see if there are any negative trends developing. You probably have a good sense of what’s happening, but it’s never a bad idea to have the specifics in front of you before you make any decisions. You can also spot cash flow glitches and accounts receivable problems before they occur so you can take the appropriate steps after considering all the alternatives. It’s always better to talk to your banker about a loan before you’re in crisis mode.
You may also have a nice surprise in store when tax time rolls around. If your accountant doesn’t have to wade through your box of dusty documents, he or she should charge you a lot less to prepare your tax return. And who knows? Your diligence throughout the year may actually enable you to lower your tax bill by shifting expenses or revenues—quite legitimately—from one year to the next, by making a timely retirement plan contribution, or by using other time-sensitive strategies of the tax-wise. You can only do those things if you’ve paid attention to the details of your bookkeeping.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
Monday, September 12, 2011
How To Finance Your Business With Bank Loans
“It takes money to make money” may be the truest axiom since “measure twice, cut once.” But look at that first statement closely. Nowhere does it say whose money it takes. If you need capital for your business (and who doesn’t?), for new equipment, materials, or to even-out the spikes in your cash flow, there are several places to get it other than your own wallet.
Let’s start, though, with the single worst source of funds: your credit cards. Unless you are sure you can pay the balance off in full before the end of the month (and if you could do that, you probably wouldn’t need to be borrowing the money in the first place), the interest is going to kill you. You won’t last long if you borrow money at 18% (or more!) to build a product where the net after-tax profit margin is 10%. And, no, you won’t make it up on volume.
Many entrepreneurs look to family and friends for loans, especially when they are starting up their company because it’s tough (although not impossible) to borrow money from a bank or credit union to start a business. Ignoring the personal relationships involved, personal loans are viable options not to be overlooked. They often carry lower interest rates and generally have a less formal approval process than those from standard financial institutions. There are a few IRS rules to watch out for, though, and there are about a thousand reasons to have a legally-binding written loan agreement signed, so consult with your attorney or tax advisor before Aunt Sadie reaches into her cookie jar.
For larger or longer loans—or if you want to avoid the psychological quagmire of borrowing money from your brother-in-law—you’ll want to turn to the people whose purpose in life is lending money: banks, credit unions, and savings & loans. The thought of going through the loan application and approval process can be very off-putting, but it’s kind of like spinach; you may not like it but you’re a better person for eating it. The process of compiling the necessary information and thinking through your proposal will help you focus on some important shop management factors.
It may not seem like it, but banks are actually eager to loan you money because that’s where they make their profits. These institutions will grant your loan if you can show that your business proposal is sound. They will turn your loan down, however, if they judge you to be a bad credit risk. While your personal credit history may be a factor in the decision, most of the time bank loans are denied because the proposal was inadequate or poorly presented. Your shop’s financial history alone is generally not sufficient proof that the loan you’re requesting is secure. For that, you need to show that the future of the business is rosy enough to make the probability of repayment very high.
Don’t even think about applying for a loan unless you know exactly how much money you need, what you need it for, and how you will pay it back. Every one of those items will need to be substantiated in some way, too. How much money you need is directly related to the amount of cash your shop generates now, so you’ll obviously need up-to-date financial statements (backed up by a CPA’s analysis and/or tax returns). What you need it for comes from your marketing plan and answers questions like who is going to buy the product you are going to make and the likelihood of their purchase based on competition, pricing, the economy, past purchases, etc. The question of how you will pay it back is answered by your cash flow projections.
Assuming your proposal answers all the pertinent questions, your financial institution is probably still going to ask for some sort of collateral and/or a personal guarantee. The collateral, of course, may include the assets (equipment and inventory) of your business, real estate, marketable securities, or other tangibles the financial institution can sell if they have to. They probably won’t consider as collateral the value of your company as a going concern—because they don’t want to operate it, which is what the bank would have to do if they took over your business in the event of a failure.
The personal guarantee is slightly different. A lien against your home, bank account, or other personal assets assures the bank not so much that they can recoup their money in the event of a failure, but that you have a strong incentive to keep running your shop and living up to the terms of the loan. They know it’s much easier for the borrower to walk away and leave the bank holding his unsold inventory than it is to give up his car.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
Let’s start, though, with the single worst source of funds: your credit cards. Unless you are sure you can pay the balance off in full before the end of the month (and if you could do that, you probably wouldn’t need to be borrowing the money in the first place), the interest is going to kill you. You won’t last long if you borrow money at 18% (or more!) to build a product where the net after-tax profit margin is 10%. And, no, you won’t make it up on volume.
Many entrepreneurs look to family and friends for loans, especially when they are starting up their company because it’s tough (although not impossible) to borrow money from a bank or credit union to start a business. Ignoring the personal relationships involved, personal loans are viable options not to be overlooked. They often carry lower interest rates and generally have a less formal approval process than those from standard financial institutions. There are a few IRS rules to watch out for, though, and there are about a thousand reasons to have a legally-binding written loan agreement signed, so consult with your attorney or tax advisor before Aunt Sadie reaches into her cookie jar.
For larger or longer loans—or if you want to avoid the psychological quagmire of borrowing money from your brother-in-law—you’ll want to turn to the people whose purpose in life is lending money: banks, credit unions, and savings & loans. The thought of going through the loan application and approval process can be very off-putting, but it’s kind of like spinach; you may not like it but you’re a better person for eating it. The process of compiling the necessary information and thinking through your proposal will help you focus on some important shop management factors.
It may not seem like it, but banks are actually eager to loan you money because that’s where they make their profits. These institutions will grant your loan if you can show that your business proposal is sound. They will turn your loan down, however, if they judge you to be a bad credit risk. While your personal credit history may be a factor in the decision, most of the time bank loans are denied because the proposal was inadequate or poorly presented. Your shop’s financial history alone is generally not sufficient proof that the loan you’re requesting is secure. For that, you need to show that the future of the business is rosy enough to make the probability of repayment very high.
Don’t even think about applying for a loan unless you know exactly how much money you need, what you need it for, and how you will pay it back. Every one of those items will need to be substantiated in some way, too. How much money you need is directly related to the amount of cash your shop generates now, so you’ll obviously need up-to-date financial statements (backed up by a CPA’s analysis and/or tax returns). What you need it for comes from your marketing plan and answers questions like who is going to buy the product you are going to make and the likelihood of their purchase based on competition, pricing, the economy, past purchases, etc. The question of how you will pay it back is answered by your cash flow projections.
Assuming your proposal answers all the pertinent questions, your financial institution is probably still going to ask for some sort of collateral and/or a personal guarantee. The collateral, of course, may include the assets (equipment and inventory) of your business, real estate, marketable securities, or other tangibles the financial institution can sell if they have to. They probably won’t consider as collateral the value of your company as a going concern—because they don’t want to operate it, which is what the bank would have to do if they took over your business in the event of a failure.
The personal guarantee is slightly different. A lien against your home, bank account, or other personal assets assures the bank not so much that they can recoup their money in the event of a failure, but that you have a strong incentive to keep running your shop and living up to the terms of the loan. They know it’s much easier for the borrower to walk away and leave the bank holding his unsold inventory than it is to give up his car.
Dave Donelson distills the experiences of hundreds of entrepreneurs into practical advice for small business owners and managers in the Dynamic Manager's Guides, a series of how-to books about marketing and advertising, sales techniques, motivating personnel, financial management, and business strategy.
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