Pricing for Profits
Sponsored by (Your Company Here)
No Margins Means No Mission:
Buy low, sell high, and keep the difference is a very basic economic premise. Every successful business exercises this principle when it earns a profit. The goal of every business transaction is to make sure that your selling price includes all of your costs , i.e., buying low and selling at a level above your costs. Knowing and understanding these principles is critical at all times, but during bad economic times like these, it could mean the difference between making it to the other side or simply learning a hard lesson.
Cutting costs in an area that decreases the perceived value of your product or services to your customers or randomly cutting marketing expenses are not effective ways to reduce expenses. Haphazardly cutting expenses in these ways can actually erode your sales causing more harm to your business. Simply increasing your selling price may not be a practical or easy fix either. Most managers do not have that much control over a selling price that is dictated more by the market. This may seem like an impossible situation for business owners and managers who have to make a profit. If you can't cut cost or increase prices what can be done?
Pricing for profits is not a hopeless exercise, but a lesson in product costing and, with a careful examination, of costs, then including all costs in your selling price. The key to minimizing expenses and maximizing margins is understanding cost. It is critical to know how they originate, where they come from, how they are used, and the impact on your organization and customers if they are reduced or eliminated. A properly set-up accounting system is the best source for this information and will produce an income and expense statement that should be the source for all of this information. All retail and manufacturing businesses produce income statements where direct material and labor costs are contained in a separate area, e.g., in retail sales it is called cost of goods sold (COGS) and produces what is called a gross profit. However, all service business including restaurants classify all expenses as operating thereby mingling direct expenses in with administrative expenses.
Every business, whether they are manufacturing or selling a product or service, can and should separate direct costs from administrative and sales costs. This produces an income statement that has gross sales at the top then all direct costs i.e., material, labor, and shipping, are deducted from gross sales producing a gross profit margin. The advantage with this kind of financial statement is that costs that drive sales are clearly and easily identified. Understanding these direct costs helps to quickly determine if adjustments in costs can be made and what the impact on customers will be. Shipping, if categorized as a direct cost may be reduced by using a different shipper. However, in this example if shipping is mingled with administrative shipping then the impact on the gross margin is misstated and the impact of reductions will be harder to determine. The goal is to recognize and properly categorize all direct costs.
The next expense area for review is administrative and sales costs, also known as indirect costs or overhead. Theoretically, cost cutting indirect expenses should be a safe way to reduce expenses without a direct impact on customer sales. In theory, that may be the case but arbitrary cuts in marketing for example, could cause a substantial reduction in sales. Remember, with marketing expenses you are essentially buying customers or sales. If your marketing is doing what it is intended to do then cutting will reduce sales. Understanding where an expense originates and how it effects your customers is critical to safely reducing expenses.
When all expenses have been evaluated and reduced, if possible, then applying our costs to the final selling price is essential. In most cases, direct costs are easily applied to the selling price as the direct relationship is easy to see. Indirect costs on the other hand, are often times, not applied properly resulting in either a selling price that is too high and lost sales, or a below market price that leads to losses in margins. The correct application of all costs and especially indirect costs or allocation will produce desirable sales and result in margins that promote your mission
Let me know if you have any comments, questions or suggestions. Write David W. Weatherholt at david@bnewsviews.com
Business/News & Views® is a business newsletter published monthly. To subscribe, visit Business/News & Views® Sign-up.
There is no annual subscription fee. Business/News & Views® is a registered trademark of Weatherholt & Associates, LLC. Copyright © 2008-2009 Weatherholt & Associates LLC. All rights reserved worldwide. The content of this newsletter may not be redistributed without the express written consent of Weatherholt & Associates LLC. Individual editorials, articles and essays appearing on this site may be republished, but only with full attribution, which must include the author and Business/News & Views® as well as a link to http://www.waconsult.com.
This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher and author are not engaged in rendering legal, accounting, or other professional services though this newsletter. If legal advice or other expert assistance is required, the services of a competent professional person should be sought.
Library of Congress Cataloging-in-Publication
Business/News & Views® / by David. W. Weatherholt
ISBN: 978-0-9823041-1-2 (electronic format)
Published in the United States of America through www.waconsult.com
Published in an electronic format by Weatherholt & Associates, LLC
First Trade Publishing: October 2008
Newsletter designed by Zoo in a Jungle Marketing, Graphics by Getty Images