Everything You Need to Know About Pricing Goods & Services
One of the most common questions we get at E-Cinch is, “How much should I charge?”. Pricing your goods and services is one of the most important tasks you’ll execute for your business and you have to get it right to be successful. If you are a first-time business owner, we suggest hiring a business coach (like Mobile Bev Pros) or getting a mentor that has business experience to help.
Before you can start pricing your products and services you first need to identify your cost of goods sold, also known as COGS.
Cost of Goods Sold
The cost of goods sold is the amount you pay for the items or services you are selling. Let’s use an example to see how you can start calculating your COGS. Some products and services are easier to price than others. For example, napkins are easy. All you have to do is see how much you pay for your napkins and then mark them up. However, you may want to buy your napkins in bulk and sell them in smaller quantities. If that’s the case, you just need to divide the cost of the item by the quantity you buy them in to get a cost per individual item.
Example: 250 napkins cost 5.99
5.99 / 250 = $.02 per napkin
From there, you can multiply the cost per napkin by the quantity you want to sell them in to get your cost.
Example: Selling by the 50-pack
$.02 x 50 = $1.00 cost per 50 napkins
To complicate things a bit more, say you want to sell freshly squeezed lime juice by the gallon. Now, you have to calculate the cost of the limes, the packaging/labels, & the estimated labor. You want to make sure you factor in all costs associated so that you can price things accurately.
Example: 1-gallon fresh lime juice
5lbs Limes x $2.65/lb = $13.25
+
1-Gallon Packaging $1.17 + Cap $0.06 + Label $0.03 = $1.26
+
Labor .5 hour x $15/hour = $7.50
Total COGS = $22.01
If you need help with cost analysis and pricing, check out our Cost Analysis Worksheet. You can also use the basic cost calculator under the Pricing Calculator section of this article.
How to Markup Goods & Services
Okay, now that we know the total cost to make 1 gallon of lime juice is $22.01, we are ready to price the item. Now, we need to decide how much to mark the product up. For this example, let’s do a 50% markup. Here’s the formula: cost x markup + cost = markup
Example: 50% markup
$22.01 x .50 + $22.01 = $33.02
or you can simplify the formula by adding a 1 to the markup
$22.01 x 1.5 = $33.02
However, if you have already priced your products and want to check what your markup is, use this formula: (Sale Price - Cost) / Cost
Example:
($33.02 - $22.01) / $22.01 = 50% Markup
*Note: Be sure that you don’t confuse the formula for markup with the formula for profit margin. The formulas are very similar but for markups, you divide the profit by the cost, and to calculate profit margin, you divide the profit by the revenue.
Pricing Calculator
Use this calculator to get more familiar with how markups and margins work.
Fixed Costs
Before you can start to calculate your estimated profit margin, you first need to add up your fixed costs. Your fixed costs are the things that you have to pay for every month like rent, insurance, payroll, marketing, etc. A healthy service business should produce 25-30% net profit. Net profit is the amount left once you’ve paid all of your expenses (COGS & fixed costs). That being said, when pricing your products and services, you want to make sure that you have enough markup on all of your goods and services so that you are covering all of your costs and still have a healthy profit margin.
First, you’ll need to add up all of your fixed expenses for one month.
Example of Fixed Expenses:
Rent = $1,000.00
Utilities = $150.00
Labor = $2,000.00
Software = $150.00
Total: $3,300.00
Projecting Your Profitability
Now that you have defined your COGS and fixed expenses, it’s time to do some projections. We know that we need to make at least $3,300 per month plus the COGS. If we price our COGS with an average 100% markup or a 50% profit margin, and our average order value is $1,500 per event, you would need to do 4.4 events to cover your costs.
Projection Example:
$1,500 x .50 = $750 profit per event
$3,300 / $750 = 4.4 events
So, if you have to do 4.4 events just to break even, how many events do you need to do to have a nice profit margin? Play with the example formula below to see how much you’ll make at 8, 12, 15, 20 events per month, etc.
Profit Margin Formula: (revenue - costs) / revenue = profit margins
8 events x $1,500 = $12,000 x .5 profit margin = $6,000 gross profit - $3,300 fixed expenses = $2,700 net profit
$2,700 net profit / $12,000 total sales = 23% profit margin
12 events x $1,500 = $18,000 x .5 COGS = $9,000 gross profit - $3,300 fixed expenses = $5,700 net profit
$5,700 net profit / $18,000 total sales = 32% profit margin
As you can see, in order to have a 20-30% net profit margin, with $3,300 in fixed expenses, you need to do 10-12 events per month at $1,500 per event. As your business grows your profit margin will vary based on hiring and increasing your expenses. But, as you grow your business, you will generate more revenue which will offset the new costs and help you improve your margin if they dip a little. You should be tracking your business’s financial health on a monthly (if not weekly) basis.
Tracking Your Business’s Financial Health
In order to track your business’s financial health, you’ll need to have bookkeeping software, like Quickbooks. With Quickbooks, you can link your business bank account, categorize your spending, and generate a profit and loss report (also known as a P&L). Doing your own bookkeeping is pretty easy but we do recommend consulting with a CPA to make sure you set everything up correctly.
Competitor Analysis
We do not recommend using competitors’ pricing to create your own because you don’t know how healthy their businesses are. However, it is a great resource to make sure that you are not overcharging. If you have a 60% net profit margin but are priced way higher than everyone else in your market, you're likely to lose most of your business to competitors and you’ll need to lower your prices to compete. This doesn’t mean that you need to be cheaper than your competitors but you will need to be within the ballpark and be able to explain why you are more expensive. This could be because you use high-quality fresh ingredients or because your staff has special training or certification, or anything else in between. There are plenty of customers out there that are willing to pay more for better service or a luxury experience.
Conclusion
As you can see, there are a lot of factors that go into pricing your products and services. It may seem difficult at first but it is crucial that you learn the formulas and understand how to track your business’s financial health. At E-Cinch, we are here to help! Don’t hesitate to reach out if you need help pricing your products and services.