Cost can be a difficult issue to address when it comes to service-orientated businesses. There is no single definition to suit all situations and the cost of a service will greatly depend on the standard of work and complexity of the job. The charge rate/service cost will also depend, however, on a number of issues including demand, business overheads, competitors, expenses, labour, materials, etc.
So before you can work out how much to charge your clients you will need to work out what your own business costs are first.
When it comes to standard costings, to accurately put a price on your service you need to be aware of what the actual costs involved in providing that service are.
It isn’t, however, always possible to obtain exact figures on the standard costs that will impact on your business, especially considering you are a new business and will not have past records or experiences to work with. In such circumstances, where you don’t know what they will cost, you can use what is called a ‘standard cost’.
You will have to factor in costs such as:
Labour and materials
Level of desired profit.
Factoring in labour and materials
Labour costs are usually quoted as an hourly rate. A little research should give you a good idea of the going rate for different positions in your business. Most positions have a wage or salary range based on the relative value of that job or function.
The highest amount usually goes to the employee(s) with the greatest experience, training and knowledge. For instance, if you are looking to award yourself a salary of $52,000 per year, the price of your labour is $1000 per week or $200 per day, figured as follows:
Annual Rate = $52,000
Weekly Rate ($52,000 ÷ 52) = $1000
Daily Rate ($1,000 ÷ 5) = $200
Check in the reference section of your library for government publications giving national and state salary ranges for different occupations. Also check for current rates with the relevant trade unions. Your local chamber of commerce may also be able to assist.
You should also gather quotes from other businesses to see the set price for services in your industry.
What are your overheads and expenses?
Overheads comprise all non-labour expenses required to operate a business. Expenses can be divided into fixed costs, which occur regardless of business operations, such as rent, and variable, those which change according to the amount of business carried out.
No matter what the volume of sales these costs must be met every month. A good example is rent paid for business premises. If the rent is $1000 per month, irrespective of profits, it is a fixed expense. Other fixed expenses include depreciation on fixed assets, salaries and associated payroll costs, liability and other insurance and rates. All of these continue at the same rate with little or no relation to the business’ income.
Most so-called variable expenses are really semi-variable. They fluctuate from month-to-month in relation to sales and other factors, such as promotional efforts, seasons and variations in suppliers’ prices. Fitting this category are office supplies, printing, postage, advertising and promotion. In estimating variable expenses, it is common to ignore month-to-month variations (unless they are large and can be accurately predicted in advance) and use an average figures based on an estimate of the yearly total. There are variations such as “semi-variable” costs. These include electricity and telephone bills. While you will receive them every month the amount will vary depending on usage.
As you may not have past operating expenses to guide you, you will have to make an accurate estimation, based on the information you have researched and your financial projections. These can be modified when you have accurate records.
Apart from the “standard” costs, such as postage, utilities such as electricity bills, rent, telephone expenses and office supplies, you will need to consider the tasks that impact on your time and how much you spend of it on one particular job.
For instance, you may need to consider the time spent on research, administration and promotion of your business. In some businesses, an allowance of 20 percent or one day per week is not considered excessive to be included in the cost to account for idle time and research.
The net profit you expect to make from your business must be included in any estimate by applying a percentage profit factor to the combined costs of labour and overheads.
This profit factor is larger than the percentage of gross revenue you are left with as your net profit.
For example, if you plan to net 20 percent profit (before tax) out of your gross revenue, you will have to apply a profit factor of about 25 percent to your labour plus overheads to achieve that target.
Pricing can be tedious and time consuming, especially if you have not had a lot of practice. If you are just starting out, it may be worthwhile to consult your accountant or financial adviser for advice on the best pricing policy for your business.
The following are costing methods you can use to charge for your services.
You will have to decide which is the best costing method to adopt for your business. The way a business charges is purely an individual choice, but will also depend on the client and the service requested.
Usually, service businesses use either the actual or standard time to perform a service multiplied by an hourly labour rate, plus (if applicable to the job) the materials used, marked-up to a retail price.
The hourly labour rate is calculated to cover both direct and indirect costs, and still return a profit. Remember, the method you choose should be based on your individual circumstances.
When setting an hourly fee remember to factor in the costs outlined previously, such as labour and overheads. It is also important to factor in your own remuneration. The level of remuneration, or the amount of wages you will award yourself, should also be factored into the service charge.
You may even decide to set a sliding scale when it comes to hourly fees. For instance, the first two hours of work may be billed at $50 an hour and $30 an hour onwards.
When working to an hourly fee it is imperative you keep a time book to keep track of how much time you have spent on a client’s request. This will be important when it comes to the billing process. It will also serve as “evidence” if ever a client queries your fee.
Make sure clients are fully aware of your hourly billing methods to avoid confusion and payment queries.
Flat fee per project
One method of quoting fees to a client is to calculate a single price for an entire project. This is quite a common method of billing.
Sometimes a client/company will want to know the total cost of a project before agreeing to engage your services.
To be able to quote a flat fee, you must accurately estimate the amount of time that will be spent on the requested task, and any supplies that will be needed.
If you quote a flat fee for a job and you can not complete it in time, you could lose money if the project runs over time and the fee quoted does not cover the expenses incurred, such as additional labour and overheads.
Flat fee quoting gets easier as your business develops and you have a better idea of how much time and effort particular work/tasks take to complete.
The important point is to have some understanding of the method involved to arrive at the quotation figure. The elements of calculating a flat fee price are similar to forecasting an hourly fee – making sure you take into account labour and materials, overhead expenses, etc.
If, for one reason or another, expenses cannot be accurately estimated in advance (for instance travel or other incidentals), you can always quote a flat fee plus expenses. If this method is used, you can, once all the expenses are in, add them up and submit the itemised list along with all receipts to the client for reimbursement at cost.
It is also important to remember if you provide a written service contract, or quote for a job to be completed, that written agreements can be binding to both parties. You do not want to find yourself in a situation where the price you fixed to the service you provide falls short of the actual costs involved.
The goal in pricing a service is to mark-up your labour and material costs sufficiently to cover overheads and generate sufficient profit. First-time business owners often fail without ever realising that they have priced their services too low.
There is one way to find out whether the market will bear your price – try it! If your competition is underbidding you, think carefully before lowering your price. Don’t work at a loss just to get the job.
A business which does not earn an adequate profit is more vulnerable to failure because it is not cushioned against costly mistakes by good profits.
If a client wants your services but does not like your price, first ask yourself whether you can reduce your profit margin without it adversely affecting revenue. If it is already marginal, it maybe better to turn down a project rather than setting a price-cutting precedent.
Discounting versus service and value
One business theory is that lowering prices will automatically increase demand. The reality is that many businesspeople reduce their prices almost to the point of non-profitability, just to compete – opening the door to potential disaster. Less revenue often translates into lower quality, weaker service and decreased customer loyalty, resulting in financial misfortune.
What your customers really want is value for money with the services you provide. Using low prices as a quick shortcut to sales probably won’t help your business in the long run, with any results being only temporary – unless you can also reduce your costs and overheads by a corresponding amount.
Anyone can imitate price, therefore customers who have been sold on the basis of price alone don’t usually have much loyalty. Not only will they be lured away by anyone who is willing to provide a greater discount, but they really won’t get to know much about the great service you provide.
Try to resist lowering your regular prices. Look at “adding value” instead, perhaps providing an additional service which costs you little or nothing to provide or bundling services where possible.
Reductions and premiums
There may be, however, some occasions when it would be to your advantage to offer a reduced price or add a premium. If a client wants immediate results, requesting you to work extended hours or increase production levels, an extra charge is not unreasonable.
Also, long term projects which may lead to lucrative follow-up business are good candidates for discounts. In these cases, you should consider the discount as an investment.
Be certain that there is a sound reason for any discount. If you lower your price too readily, the client may believe you were trying to overcharge him in the first place.