Using the budget
One purpose the annual budget serves, which many people are unaware, is the assistance it provides when creating your pricing structures for the upcoming year.
The concept of pricing is a complicated subject. There are countless books written on it and many different theories on pricing strategies. For example, if you asked a dozen accountants for tips on how to determine appropriate pricing for your business, you would likely get several different answers. Often, the most dangerous advice you will get is to model your pricing strategy based on ‘whatever the market will bear.’ This is probably the single most surefire way to quickly put your company out of business.
Pricing your work ‘at the market rate’ will not work, at least not in the long run. Every individual company has its own internal cost structure, and in using someone else’s prices you cannot expect them to allow your business to turn a profit. It may result in you getting work, but there is no guarantee you will make money. You will more than likely lose money.
By using your annual budget, you will be able to calculate three important numbers, which are the lifeline of any business:
- Overhead recovery rate.
- Breakeven.
- Net profit or profit margin.
Watch your overheads
Overheads are large expenses for many businesses. They comprise everything from office wages, insurance, phones and utilities to advertising, meals, entertainment and other miscellaneous costs. These overheads are also referred to as fixed or recurring costs. Job costs, COGS, are not considered an overhead expense.
Overheads get paid regularly by a business regardless if work is performed or not. For instance, during a slow period, even though COGS are minimized or non-existent, overheads still need to be paid. Sometimes, overheads actually increase (at least temporarily) during these slow periods because the business is trying harder to find new work, resulting in increased marketing and advertising expenses.
Overheads must be recovered by the job costs. Several methods are available for recovering overheads in the pool and spa industry. Some of the most successful include:
- Single overhead recovery (i.e. on labour)
- Dual overhead recovery (i.e. on labour and materials)
- Multiple overhead recovery (i.e. on labour, material, equipment and subcontractors)
At the end of the day, you should determine which overhead recovery method works best for your business and then use it consistently. As long as you are recovering (paying back) your company overheads, that is all that matters. Some methods may be more effective and even more advantageous from a pricing strategy; however, this would be beyond the scope of this article and would be an entirely separate subject of its own.
With your overhead recovery rate calculated (usually expressed as a percentage of the COGS), you know how much you need to charge for each product or service as a percentage of your job costs to recover the proportionate amount of overheads. In doing so, you should recover your total overhead amount by yearend.
