The dream to build a profitable business is an attainable one. But it takes work. Every business owner strives to have a profitable business. We often get caught in a trap thinking we need to hustle harder and get more clients to increase our sales and thus increase profitability. There are many ways to increase your profits… and your sales volume shouldn’t necessarily be your main focus. Instead, follow these steps to determine the price you need to charge to build a profitable business.
Steps to help you determine the price which will ensure you are profitable
Let’s start with your desired outcomes and work our way back to the price point which will help you achieve those goals. I will be using an example of a photography business the whole way through to demonstrate how to implement this in your business.
What to pay yourself while you build a profitable business
It is important that you are paying yourself for all the hard work you are putting into your business. You are it’s number one employee so you better be compensated for your time. The best way to determine a base salary is to review your personal finances. What do you need to take home to cover those expenses plus allow you to live the lifestyle you desire? Be realistic, if you are just starting your business you can’t pay yourself a yacht lifestyle salary right away. Think about it like, what is a salary you could pay yourself in order to make you feel proud and allow you to stay motivated to run your business?
Example: After listing out all personal expenses in a month, a photographer determines that she needs to take home $6,000/month to have the lifestyle she wants
Know what you want to make in profits
What kind of profits do you want to make in your business? First we should discuss what I mean by profit. I am not referring to the number at the bottom of your income statement. That doesn’t take into consideration all the cash in your business. Profit is the money you have left over after you have paid all your expenses, paid yourself and paid your taxes. Ideally it is the physical cash sitting in a separate bank account waiting for you to pay it out to yourself as a bonus.
Some businesses consider their profit to be what is left over after paying their expenses and then they get to pay themselves. But as I said in our first point, the business should already be paying you a base salary. Since profit is the money left over after everything else has been taken care of, don’t worry about it being a huge number.
To give you an idea of some profit percentage of fiscally healthy businesses. A business with real revenue which is (sales less materials & subcontractors) of $0 – $250,000 should have a profit of 5% and a business with $250,000 – $500,000 in real revenue should have a profit of 10%.
Example: The photography business has $200,000 in annual sales. They don’t have any materials or direct subcontractors in their business so the $200,000 is also their real revenue. Based on that, a profit of 5% is her goal by the end of the year. However, since she is just starting this process she will be conservative and start with 3%. This would be $500/month.
Know all your costs
This is important. Sometimes when we price our products and services we only look at the direct cost of it, add a little profit and set the price. However in doing this, we forget that our businesses can have a lot of other costs that are not directly related to our product or service. For example office rent, buying a new computer, office supplies… and don’t forget if you have debt payments.
Every sale has to pay for a portion of all of those costs.
Example: Our photography business has listed out all of her expenses for the year then divided it by 12 to get an average monthly expenses of $5,000/month. Doing it this way ensures she catches the expenses that are not paid for on a monthly basis.
Don’t forget your taxes as you build a profitable business
We need to take into consideration the taxes we should be saving for each month. To simplify your calculations you should be setting aside about 10-15% of your revenue for taxes.
Example: With $200,000 in annual sales our photographer usually owes about $20,000 in tax each year. She decides she wants to save $1,600/month in taxes to cover her tax bill.
Be aware of your capacity to build a profitable business
Your capacity has a major impact on your pricing strategy as you build a profitable business. If you know how many clients you can effectively work with each month, then you are able to set a price that will allow you to realistically meet your goals. If your price is too low you will end up taking on more and more clients to hit your sales target. This could potentially cause you to burn out or lower the quality of your service/product you are offering.
Example. The photographer specializes in family sessions and can work with about 40 clients per month. Now that we know what she wants to pay herself each month, desired profit and her total expenses, we can add that up and divide it by her capacity.
Owners pay $6,000
Total cost $13,100
Minimum Price $327.50/client
We say that is the minimum price because that is based on her working at capacity each month. That isn’t realistic so she increases her sales price to $425/session which is about 30 clients per month. That will give her a buffer in her slower months to ensure she can still hit her goals and to build a profitable business.
Regularly review your prices
Your business is always changing and therefore your prices need to reflect that. The price you set for a product/service 2 years ago may not be the best price for it anymore.
Changes can occur like, the cost of materials, your staffing or your workload to name a few. Sometimes the changes are gradual and you don’t notice them right away but if you review the profitability of your pricing on a regular basis you will be in control of where your profit ends up.
For example, say you provide a monthly service to a client who has been with you for a couple of years and your monthly fee is $400. Originally, you did about 5 hours of work for them each month. However, over the past year the amount of work you do has gradually increased to 8 hours per month. You have gone from making $80/hour to $50. Knowing your business needs to make a minimum of $60/hour to be profitable you can go back to the client with a new monthly quote of $480/month.
As I hope I have shown, having an in-depth knowledge of your business sets you up for success. With this information, not only can you price your goods and services appropriately, you can build a profitable business and maintain healthy finances. Try a client management software for small businesses to help you get started.