3.16 and Pricing Your Products

(This is from a post of mine on September 1st 2009)

First let me say that I am not an accountant, my information here is only a general guide, some of you will already be doing some of what’s suggested, some of you will be completely baffled by some of the information and others will decide that it’s not for you.

The main thread of this is pricing your products, but to price your product you need certain information and to make certain decisions.

Remember that when you sell something you need to make a profit, but what is a Real Profit and what most people think is profit is two different creatures.

You can price your products one of two ways, either ‘cost plus’ (which is the method I favour) or ‘Value based’

Remember that the price you set for a product today, can be reviewed at any time, and that using odd pricing can bring in more sales (pricing an item at £9.95 rather than £10 is called odd pricing).

Now I’m going to assume that everyone is a Sole Trader, but the rules are only slightly different for companies.

Value based pricing is the method most people have been using and is something that leads to more businesses failing than any other factor. Your price is set by what you think (with a little research) the market will pay for your goods. The problem with this, and it is very common on folksy and crafters in general is that you don’t even cover your materials cost, and all your other costs are either ignored or you are not even aware of them.

My personal reasons why this is wrong is because you never make a profit, you may think you do, but you don’t, let me explain Cost Plus pricing and why it’s more effective, and you’ll see things that will tell you why you don’t make a profit.

First to use the ‘cost plus’ method, you need to know your costs, simple you’d think! Knowing your costs means more than just knowing how much your materials cost.

Working out your Costs
Some basic accounts need to be used to work out costs, but accounts are only as good as what you include, so what should you include
Fixed Assets costs……what are they?
A fixed asset is something that you do not intend to resell, in my case, machines such as band saw, drill press, bench sander, scroll saw, Computer, Printer, Work benches, Chairs, task lights, all my hand tools, etc,
Overheads….. what are they?
Expenses incurred in running the business, they can be broken down into Production costs, sandpaper, wood, jewellery findings, oil, drill bits, saw blades, packaging basically everything you use to make your products except materials (keep a separate list for Materials (you’ll need to do a traditional how much it cost in materials later), Premises such as rent, electricity, gas, rates, telephone, Product liability insurance, General liability Insurance, premises insurance, do you have your stock insured, both during transit and storage. etc, Sales & Promotion such as listing fee’s, transaction fee’s, Stationery, Business cards, postage cost’s (sending out info, not goods), Internet (Broadband), Domain hosting, everything that you pay for monthly or yearly. General Costs, thing you can sub divide if need be, transportation, education, professional subscriptions and memberships, accountancy and bank fees, interest payments on loans, don’t forget that you may even be able to claim for personal protective equipments (mine include safety boots, Safety Glasses, protective gloves, foul weather clothing for craft fairs in winter, and sun cream for summer events) etc Sundry/Miscellaneous Items for which there is no other category or which happen so seldom that they are not worth listing separately.
If you add most of the totals from above together (except materials cost) and then divide that total by 1680 (average hours worked per year) that will give you an hourly background cost (for the sake of the rest of this data sheet well say £3.68)
Wages Now you may not thing you employ anyone, but you do, yourself, what about Insurance, both personal and N.I., (general and loss of earnings, a pension for you, even private medical insurance (cover for optical and dental?). Do you cost out your hourly rate (say you would like to earn £25,000 a year, break that down to an hourly rate not just for production time but also for sale, promotion, IT, Accounts etc. 25,000 divided by 52 weeks is about 480 a week or about £12 per hour).

Knowing how much all the above will cost you is the Key to making a profit, but in your first year you may not know how much this will cost, and if the price of one thing goes up, it can throw out your prices (why it’s important to review prices).

A simple formula was worked out by some accountant many years ago, after years of analysing accounts, they came up with cost (clear upfront costs such as materials, labour, listing fees etc.) multiplied by 3.16, now as with most things that accountants do, there are whole books on how this was worked out, and as it is in wide use, I’m not saying trust it blindly, but for me it works.

So how does it work and how do you use it?
Say that your materials cost you £2.00, and labour £6.00, and our background cost is £3.68 = £11.68,
So do you sell the item for £11.68 plus postage and listing costs? No! You still have to pay income tax on what you earn, and what about a bit of profit, and in six weeks a wholesaler wants to sell the item, he wants a discount or he won’t take your goods,
Now we use 3.16 to get our retail price, so £11.68 X 3.16 = £36.91, that will be our recommended retail price. If you need to sell wholesale you can divide by 2 (which gives £18.45 which still leaves a small margin of profit). Now you may feel that your price is to high at £36.91, so if you do craft fairs etc you can always display a Sale Sign stating 20% discount off retail price for direct sales (So your price drops to from £36.91 to £29.53).
Please don’t shoot the messenger, but in the business world you need to make a profit or else there is no reason for being in business (unless you want to be a not for profit company or a charity). All business need to make a profit, the best way is to keep costs down.

There are many books on accounts for small businesses available from you local library, my advice to anyone is to keep every receipt, even for petrol (don’t claim every mile your car does, but keep a record of the vehicle mileage and claim the current allowance (see revenues web site).
There are unlimited places to look for help; some of the best are the tax office, Businesslink, Federation of small businesses.

The above is not to be considered as a guide for bookkeeping. Once again this needs to be set up correctly
You should have several spread sheets
Purchase (separate for purchases on credit & Payments), Sales (give each product a stock control number and link your sales spread sheet to your stock control sheet, this should then be linked to a production control spread sheet, that can tell you what stock your running low in), Petty Cash, Bank Balance, Stock Control (stock on sale or return, stock on hand, stock donated, damaged stock, all sorts, mine includes sub sections for each range of products, pendants, bracelets, necklaces, rings, etc).
I hope you find the above enlightening. And I’m sorry if this frightens some people. There is always a place for those who different point of view. Is your way better, do tell.