Picture the scene, a new entrepreneur is gathering her books and records to give to her accountant at the end of the year, happy in the knowledge that the business has done well. There is €10,000 in the bank account and she is wondering whether her accountant can reduce any potential tax bill. But when the accounts are presented to her, she has made a loss. How did that happen? There's money in the bank. However, suppliers haven't been paid in weeks and the busines is behind in its payments to the Revenue.
All too often, when we look into the accounts in more detail we find that the reason a loss is being made is that business owners are not pricing their product or service correctly. It’s all well and good making plenty of sales but if you are losing money on every sale then you won’t make a profit no matter how much you sell.
We’d recommend that before pricing a product or service, you should do a calculation and consider three items:
- The cost of the goods
- Your overheads
- Your profit margin
For example, if your business is selling computers and you purchase a computer for €300 then what price should you sell it for? Firstly, you need to take into account the cost of the goods to you i.e. €300 and if you sell it for anything less than that then you will undoubtedly make a loss.
Next, consider your overheads, by which I mean all your business expenses other than buying the goods in the first place. So you would include here items such as wages, rent, telephone, motor expenses and so on. If your annual overheads amounted to €60,000 then you should allocate this cost over the expected number of sales in the year. If you expect to sell 500 computers then you would allocate €120 (€60,000 / 500) of overheads towards the sale of each computer.
Finally you need to add on a profit margin. If you hope to make an overall net profit of €20,000 then again allocate this over each expected sale to arrive at a profit per sale, in this instance of €40 (€20,000 / 500).
So having considered all of the above, in this case, your selling price should be €460 (€300 + €120 + 40). You might find that having done your calculations that you arrive at a price which is higher than your customers are willing to pay in which case if you lower your price then you are reducing the profit you will make. You should however always bear in mind the minimum price you need to get to cover your costs, often referred to as breakeven point, which in this example is €420 (€300 + €120).
Note that all these calculations should be done on an ex VAT basis as any VAT paid or charged by your business will need to be reclaimed or paid to the Revenue.
While the above is a very simplified example, the same method can be applied to any business model. Just remember to allow enough in your selling price to cover all your overheads and be realistic on how much you think you can sell. Finally, don’t forget to redo the calculations on a regular basis to take into account any increase or decrease in expenses. Don't wait until the end of the year to do your accounts. Monitor your margins and your accounts throughout the year.
If you have any queries on the above, please call me on 021 4310266 or email firstname.lastname@example.org.