Read Start Your Own Business Online
Authors: Inc The Staff of Entrepreneur Media
Start Your Own Business (106 page)
Let’s compute markup for ABC Clothing for Year 1:
Now, let’s compute markup for ABC Clothing for Year 2:
While computing markup for an entire year for a business is very simple, using this valuable markup tool daily to work up price quotes is more complicated. However, it is even more vital. Computing markup on last year’s numbers helps you understand where you’ve been and gives you a benchmark for success. But computing markup on individual jobs will affect your business going forward and can often make the difference in running a profitable operation.
In bidding individual jobs, you must carefully estimate the variable costs associated with each job. And the calculation is different in that you typically seek a desired markup with a known cost to arrive at the price quote. Here is the computation to find a price quote using markup:
(Desired Markup x Total Variable Costs)
+ Total Variable Costs = Price Quote
Let’s again use ABC Clothing as an example. ABC has been asked to quote on a job to produce 100 dozen shirts. Based on prior experience, the owner estimates that the job will require 100 labor hours of direct labor and five hours of supervision from the plant manager. The total material costs based on quotes from suppliers (fabric, sewing thread, buttons, etc.) will be $40 per dozen. If ABC Clothing seeks a markup of 42.9 percent on all orders in Year 2, it would use a markup table (like the one on page 680) to calculate the price quote.
AHA!When you set up your computerized bookkeeping system to create automatic monthly financial statements, make sure you also automate your business’s financial ratios. There’s no sense in having to compute them manually when the information is available on your PC. Reviewing financial ratios monthly will help you keep an eye on your business’s financial trends.
What if you are a new business owner and don’t have any experience to base an estimate on? Then you will need to research material costs by getting quotes from suppliers as well as study the labor rates in the area. You should also research industry manufacturing prices. Armed with this information, you will have a well-educated “guess” to base your job quote on.
How you use markup to set prices will depend on the type of business you are starting. If you are launching a manufacturing, wholesale or retail operation, you will be able to compute markup using the aforementioned formulas to factor in all the variables in the cost of producing or generating the items you will be selling. Markup can also be used to bid one job or to set prices for an entire product line.
If you are starting a service business, however, markup is more difficult to calculate, particularly for new business owners. With most service businesses, the key variable cost associated with delivering the service to your customers will be you and your employees’ time. In computing proper markup for a service business, you must pay close attention to the time spent to provide the service to customers, as well as to market prices of the services provided. In starting a service business, you will need to research the going rate paid to employees and the market prices for the services you will be providing.
For instance, if you are starting a staffing service, you will need to know what rate is typically paid to employees in this industry as well as the market rate charged to your customers for temporary labor. This will enable you to compute the proper markup in setting your price to ensure that you will be profitable.
Markup Computation for ABC Clothing Price Quote
(See the “Markup Computation” chart on page 680 for how the price quote was calculated for ABC Clothing, as shown below and on page 682 for price quote worksheets you can use in your own business.)
Price Quote Worksheet for a Service Business1. Depending on the type of service business, there may be many more labor contributions. All should be considered.2. Derived by adding together Total Labor Cost & Other Variable Costs3. Stated as a percentage markup on the costs to provide the service. In most service businesses, this will range from 25% (0.25) to 100% (1.0).4. Price Quote computed as follows:Total Labor Costs + Other Variable Costs + ([Total Labor Costs + Other Variable Costs] x Desired Markup)
Price Quote Worksheet for a Nonservice Business1. Depending on the type of company, there may be many more labor contributions. All should be considered.2. Depending on the type of company, there may be many types of materials used to produce a product. All should be considered.3. Derived by adding together Total Labor Cost, Total Materials Cost & Other Variable Production Costs4. Stated as a percentage markup on production costs. In some businesses, this may be as low as 5% (.05); in others it might be 100% (1.0) or higher.5. Price Quote computed as follows:Total Labor Costs + Total Materials Costs + Other Variable Production Costs + ([Total Labor Costs + Total Materials Costs + Other Variable Production Costs] x Desired Markup)
One useful tool in tracking your business’s cash flow will be the break-even analysis. It is a fairly simple calculation and can prove very helpful in deciding whether to make an equipment purchase or in knowing how close you are to your break-even level. Here are the variables needed to compute a break-even sales analysis:
• Gross profit margin
• Operating expenses (less depreciation)
• Total of monthly debt payments for the year (annual debt service)
WARNINGYou must include break-even analyses as part of your pricing policy to ensure you’re making money on every unit you sell and that you’re able to be profitable based on your costs and sales. If you’re not profitable, you won’t stay in business. It’s as simple as that.
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