When starting a business, you often have very few overhead costs. Most of us start as a one-person show working from home, and the initial prices we set for our services are sufficient for a small business to profit.
As businesses grow, financial management and profitability tend to suffer. Service rates and product pricing often lag behind a business’s overall growth and are slow to catch up. Don’t lose the passion you had when you started your business! Instead, re-evaluate your business expenses, service prices, and profit and loss margins.
In this post, we cover key financial management strategies for your business, which will also increase your profit margin. Who doesn’t want that?
The reality is that every business needs to make a profit. Profitability is even more important if you have employees who are depending on annual raises and vendors with rates that increase for inflation each year.
How to Improve Profitability: 3 Things You Can Do Today
These calculations and strategies will help you correct your business’s poor financial management and increase your profits:
- Review your income compared to hours worked.
Determine how much you earn and divide that amount by the number of hours worked. After reviewing this analysis with our clients, many learn that they’re earning a little over minimum wage. That is not acceptable! - Re-evaluate your cash flow.
If your business is running a month-to-month operation and has no emergency fund or sufficient reserve, you need to reevaluate your service rates and business expenses. For example, many businesses had to halt services at the beginning of the pandemic, but their overhead expenses (rent, for example) continued. You need to account for overhead costs in months where your earnings will decrease or cease altogether. - Check out your competitors.
Many of our clients neglect to review what their competitors are charging. They’re busy providing services to their clients, not checking out the competition! Sometimes when performing market research, we find that our clients are not only busier than their competitors, but they’re busier because they are charging less. More time spent and lower service prices do not equal profit.
Now that you know what cash flow changes you need to make, how do you go about determining what your service rates should be? We can help you with that too.
How to Determine Pricing for Services
Figuring out what to charge is a daunting task. You want to be fair to your customers and be competitive in your field, but your business also needs to turn a profit. Here’s the process for determining how to price a service:
- Figure out how much you would make as a W-2 employee.
If you were a full-time employee, you would likely work 40 hours per week. If you multiply 40 hours by 52 weeks in the year, you get 2,080—the total number of working hours per year. Take your hourly rate and multiply it by 2080. Now you have your theoretical base salary as a full-time employee. - Now, double the base salary.
You need to double the base to cover overhead costs: staff salaries, benefits, rent, taxes, etc. - Take your doubled base salary and double it again.
Now you have the salary that you, as the business owner, should be earning. Why? You built a thriving business, and you need to be compensated based on your effort and expertise.
If you run a business, you know that expenses increase from year to year. Rent goes up. Vendor rates, product prices, merchant fees, and delivery charges all increase. Many business owners don’t take the time to review annual increases relative to their profit margin. Calculating all overhead costs allows you to determine the operational cost of goods sold.
While raising your rates and increasing product prices can be difficult, it is important to do so. Charging what you’re worth allows you to better serve your customers and support your team.
Plan to meet with your CFO quarterly, minimum, to ensure that your business’s finances and profit margins are on track.
Want to watch a video instead? Learn about the top money mistakes people make with their small businesses:
Further reading:
Business Vehicles and Tax Deductions
Photo by Towfiqu barbhuiya on Unsplash
