Your business background could be a great help or hindrance when it comes to setting the pricing for your new small business. If your background is in the same, or related, field then you’re going to have a leg up on those that do not have that background. Those of you that are choosing to start a new business in an unrelated field are going to have some work to do. We’re going to explore the three situations that could apply and what to watch out for when pricing your service.
Business Owner #1
Let’s say you’re currently working in a field and have decided to branch out and start your own small business. Congratulations! At your 9-5 job the pricing and managerial responsibilities are yours alone. This is one of the easiest, but can also be one of the most dangerous, situations for starting a small business. The template has already been set and you have the training needed to price your product or service. The thing that makes this scenario so dangerous is the reality of your costs and overhead. They will most certainly be different in your new venture. If you use the same calculations and costs from your previous job your numbers could be way off. The other caution is that of being realistic with your costs. New business owners often don’t realize what costs are really involved in operating their own business. They believe it can be done cheaper or differently. This could be the case and possibly a great reason for starting a new venture, but tread lightly and keep accurate records for costs and progress.
Business Owner #2
This is the business Owner working in a related field with the needed technical skills but knows nothing about how to price the service. The bonus here is that you have the technical skills to get the business going and get the work done (or manage its completion). The drawback is that you don’t know how to run the business or price your service. Don’t worry, we’re going to help!
Depending on the type of business, you’ll find one particular expense will stand out as the line item where most of your money goes. For most service businesses this will be the salary for the business owner(s). The time you spend working in the business is probably one of the most overlooked expenses in small business today. Some owners don’t value their time or the business doesn’t have the income to pay a living wage. This can be a major problem. If you can’t support yourself and your family what is the point in having the business in the first place? Here are some tips about valuing your time and pricing your service. These tips will apply to any of these startup situations.
As the business gets off the ground you’ll have to start by making some educated guesses about what your costs are going to be and how much to charge for your time. Doing research on other similar businesses in your market to determine what they’re charging for the same or similar service can be a great place to get some comparison. If the business is purely service and you’re selling your expertise it will be a little easier than a company that’s providing an in-home service with employees and a physical location. Even then, it would probably make sense to start your business small and build up to having employees and a location. This is how you avoid getting in over your head with major expenses right out of the gate. Because you have experience in this field you’ll know how long it takes to get things done for your clients. Use this information to estimate how many hours it will take to complete projects either on an hourly basis or a task-specific basis. Once you know how many hours it will take to get the work done then determine your other costs. Here are some costs that we would consider ‘overhead’ and must be factored into the cost of the service. Overhead is the cost associated with running the business and not necessarily with manufacturing and producing a specific product. Overhead would be things like:
- Office or Rental expenses
- Office supplies (computer, paper, desk)
- Utilities (phone, internet, electric, gas)
- Office manager or bookkeeper
- Accountant
- Lawyer
- Marketing expenses (ads, website)
- Vehicles
- Licensing and other regulatory fees
- Other equipment needed to perform the service
- Insurance
If you’re a sole proprietor there will be some other costs that could be considered overhead like:
- Health insurance
- Cellular phone
- Travel expenses
The other category would be costs attributable to a specific project or client. These are called ‘job costs’ and some examples would be:
- Supplies bought specifically for one project
- Travel to and from one specific client if extraordinary
- Contract consultants for a specific client project
- Sub-contractors
Once you have a reasonable handle on the expenses, do some math. Start by annualizing your overhead expenses. In other words, how much do you spend annually on all these things? Break down the annual cost to a billable hourly figure (see explanation of billable time below). When you know the number of billable hours you can divide that number of hours into how much you spend each year on overhead. This allows you to calculate the overhead costs in an hourly unit. Make sure you figure what your time is costing on a billable basis too, not the hourly rate you want to make. The reason for this adjustment is as such; when you’re performing your service for clients, realistically, you may only be able to bill clients for 70-80 percent of your time. The other 20-30 percent of your time will be spent marketing, billing or otherwise working on the business and not for clients. This means you will have to use an hourly cost much higher than the $45.00 per hour.
Here’s an example; you would like to make $45.00 per hour as your gross income 40 hours per week for 52 weeks a year. This would be a gross annual salary of $93,600. As you do the math for your number of billable hours you find that you can charge 1,498 hours per year to clients instead of the full 2,080 (this is assuming a 72% billable hour percentage). This means that you should be charging at least $63.00 per hour not including profit mark-up or overhead costs. Here’s the math:
2080 x .72 = 1498 billable hours
$93,600/1498 hrs = $62.48/hour
After you have the hourly costs for time and overhead you can add them together and apply a multiplier for risk and profit to arrive at the final billable cost. Make sure you give yourself some cushion for the unknown and all the risk you are assuming as the business owner. Don’t just mark everything up 10 percent and call it a day. Be realistic about the risk you’re taking and how much money you want left over after paying yourself and expenses. Risk is something that most small business owners don’t think about. You’re not buying a job; you’re assuming liability and risk. This is a real cost and needs to be accounted for in your pricing!
Hourly estimates for costs is one way to do the math, you can also calculate it based on the percentage of total revenue. Using percentages is a little more complicated but it can be more accurate too. You should start out working the numbers hourly and decide when the time is right to convert as the business grows.
Business Owner #3
The last situation is the new business owner who is starting something in a completely unrelated field. This person is surely in for a little trial and error. Don’t worry though; this is where we started our business so we know it can be done! All the principles for business owner #2 still apply but now you have to get a good handle on how long it’s going to take to complete the tasks. If you constantly blow (go way over) the hours on your projects it could put you in a bad spot. The greatest piece of advice here is to keep painstaking records on hours to use for historical data. This data will have to be referenced frequently in the beginning to determine if you’re charging enough for what you do. It could also make sense to hire someone with experience as an employee or hourly consultant to help you in the beginning. This doesn’t get you out of the record keeping but it could be very helpful to avoid common technical mistakes associated with your trade. Be sure to allocate their expense in the fees you’re charging.
In conclusion here are two, unscientific, general rules. If you’re getting tons of work and not making any money that’s usually a sign that you’re not charging enough. On the other hand, if you don’t have any work it could be because you’re charging more than the market can support or you have a sales/marketing problem. This means you’ll have to review your costs and determine where to cut or, improve your sales/marketing skills.