PRICING & PROFIT MARGINS

January 28, 2019 Hansie Britz

                              

Pricing your product is one of the most crucial aspects of marketing. Essentially, price determination is about how much consumers are prepared to pay or your company’s offering. Once you have competitors, it means consumers are faced with a choice. Quite simply, they can buy your product/service, or they can buy that of the competition. And, despite what pundits say about the swing towards companies providing service excellence, people in a depressed economy are hugely influenced by price.

The following tips will help you set the tariff you charge for your products/services in such a way that you will not be short- charging yourself.

KNOW YOUR PRODUCT

Separate costs into two columns – fixed and variable costs. Fixed costs are those costs that need to be paid whether you operate or not, while variable costs fluctuate with output.  Fixed costs are costs like Rent, Leases, Vehicle repayments, Salaries, Royalties while Variable costs include Advertising, Wages, Labor, Commission.

Having identified your costs, forecast the sales quantities. From this estimate, the fixed cost component is established by dividing the fixed overhead amount by the sales quantity forecast. Add the fixed cost and variable cost per unit together to get the total unit cost.

MARK – UP VS GROSS PROFIT

Know the difference between 40% mark up and 40% gross profit when discussing profitability. A 40% mark up yields far less profit than a 40% gross profit. This is because the percentage mark up is calculated on the cost price whilst the gross profit percentage is calculated on the selling price.

KNOW INDUSTRY COST STRUCTURES

Most industries have developed an informal guide when pricing good and services based on input costs and these statistics provide a useful starting point when determining the selling price. For instance building contractors will allow between 50& 60% of a contract price for materials. The computer retail industry allows about 87%.

PRICING AND BREAK – EVEN

The selling price determines how quickly your company can pay for its fixed costs and thereafter make a profit. Knowing your company’s cost structure and unit profitability will allow you to determine the precise point when revenue exceeds fixed costs. Use this point to set production, sales and turnover targets. These figures can then be monitored on a periodic basis. The calculation of the break even point is as follows: If a company has fixed costs of R5000 per month and a gross profit of R5 per unit sold it must sell 1000 units per month before the company makes a net profit. Sometimes the break even point is expressed as a capacity percentage. Using the same example above, if the company capacity were 1500 units per month the break even point could be expressed as 1000/1500 or 66.66% capacity.

WHAT IS YOUR PROFIT MARGIN?

Profit margin (also called operating margin) shows how much profit your business makes on every rand of sales, before paying interest payments or taxes. It is usually expressed as a percentage. So, if your business has a 10% profit margin, that means that 10% of your sales are left over as profit, after you’ve paid all your regular expenses such as salaries, rent, and raw materials.

Why is your profit margin important?

Your Profit margin shows you how good your company is at generating income from normal operations of the business, after you’ve spent money on marketing, sales, product development, and so on. Over time, successful companies should develop a higher profit margin. This means that the company is making more on each rand of sales. To assess whether or not this is happening compare the company’s quarterly or yearly figures to those of the previous year or quarter, and to competitors, if possible.

How to improve your profit margin:

To improve your profit margin, you need to either spend less or bring in more revenue. There are a few ways you can do this:

1. ‘Trim operational waste” – For example, cut down on raw materials used during the production process.

2. “Make the most of your employees time”. Synchronize production processes, avoid long delays between tasks, and organize time better to avoid bottle-necking.Give idle employees something to do that will cut down on operational waste.

3. “Consolidate processes”. Spend some time evaluating and analyzing the various systems, you use to run your business. If something is inefficient, change it or get rid of it. The goal is to increase efficiency.

4. “Review your expense budget”. To understand how to improve your profit margin, you need to know where you are spending money. Take a look at or payroll expenses marketing budget, the cost of materials, and so on. Where is the money going? How can you cut costs?

5. “Compare your figures with industry averages”. Once you’ve figured it out where you’re spending your income, take a look at industry averages. How much is the industry spending on each part of their operations? Once you’ve figured this out, you will be able to look for more specific ways to improve your profit margin.

NEED MORE INFORMATION ON THIS OR ANY HELP WITH PUTTING TOGETHER A PROFESSIONAL BUSINESS PLAN CONTACT US NOW AT: 084 583 3143 or money@global.co.za