What It Really Costs You to Do Business

If you want to make more money in your business, you must know what it really costs you to do business.  When it comes to business finances, most business owners concentrate on the big picture. They want to know how much revenue they brought in, how much they paid out in expenses, and whether there is any money left over at the end. If they have more money than month, they’re happy. Unfortunately, they still don’t know if they’re really making money.

Rather than focus on the overall monthly total, business owners need to focus on the individual parts. That is, they need to know whether they’re making money on each type of product or service they offer, breaking everything down to a cost per unit, cost per project, or cost per service.

Why? Because if you don’t look at the “cost per,” then you’ll never know for sure whether a certain product or service is profitable and worthwhile. Realize, though, that determining the cost per item means more than simply calculating the costs for raw materials and labor. You must also look at the indirect costs associated with doing business and then allocate a percentage of those indirect costs to each product or service you offer.

For example, let’s say you produce two glassware items. One item is high-end, while the other is fairly inexpensive. If you don’t know the cost per product for each glassware item, then you could be losing money on one product and not even realize it. So let’s suppose that you sell the high-end glassware for $40 per piece. Your cost for raw materials and labor is $30 per piece. On the surface, you may think you’re making money on this item—$10 per glass. But you need to take your analysis a step further. Now you need to look at the indirect costs associated with producing this product—the costs for doing business.

After some calculating, you realize that for every piece of glassware you produce, you must tack on an additional $10 per piece to cover your indirect operating expenses. Now you’re only breaking even on that high-end glassware line. So while you may have a bottom line that’s in the black (apparently due to the lower priced item), you’re not really making any money from this high-end product.

At this point, you need to decide whether breaking even or possibly losing money on an item is acceptable, because you’re using the product or service as a loss leader. If so, then that’s okay so long as you’re making a conscious decision about continuing the item despite your lack of profit from it. If not, then you need to decide whether to discontinue the item or raise your pricing for it.

To help you figure out your real cost of doing business, follow these guidelines:

  1. Determine your indirect costs. Some people call this the “cost of doing business.” Indirect costs can include salaries for those running the company; fringe benefits; facility costs; organizational costs such as, legal, accounting, and administrative fees; travel costs for executives; personnel costs; health insurance premiums for employees; business insurance premiums; marketing expenses; and daily operating costs such as phone service, electricity, and water. While all these costs and more are necessary for the business to run properly, you can’t assign them to one particular product or service. These are the items you need just to keep the doors open so your employees can produce your produce or deliver your service.
  1. Allocate your indirect costs appropriately. Now that you know what your indirect costs are, total them up so you have one large figure. Next, you need to allocate that money appropriately to all your product or service offerings. The best route is to allocate the indirect costs on a percent basis so it’s fair to each service or product line. You may choose to allocate the percentages evenly. For example, if you have two products, you could allocate 50% of the indirect costs to each. Or, you may choose to do an uneven allocation, where you allocate a higher percentage to those things that take up more space or require more administrative work. For example, for those same two products, if one takes up 80% of warehouse space and the other only 20%, you may give a higher percentage of your allocation to the larger product. Either way is fine; just make sure your method makes sense and is fair.
  1. Get the grand total. With your indirect costs and allocation method in hand, determine the direct costs for you to produce each product or deliver each service. To each figure, add your appropriate indirect cost allocation amount. If you need to estimate any part of this figure, be sure to err on the high side. Now you have the real cost required to produce your items.
  1. Compare the true cost to the selling price. Finally, determine if you’re making enough of a profit on each item to warrant its production or delivery. For example, with our high-end glassware example from earlier, after doing the math, we found that we were breaking even on the product’s production. While breaking even is far better than losing money, breaking even won’t make you rich or enable your business to grow. Should you discover that you’re losing money each time you produce a certain product or deliver a particular service, do some research to find out if the market could bear a higher price. If charging more isn’t an option, then you need to decide if it’s really worth producing the item.

Make More Money…Indirectly!

While the actual process of determining your real operating costs may seem simple, few companies actually do it. They don’t bother factoring in their indirect costs to every product, project, or service, and as such they never really know if they’re losing money, getting ahead, or just breaking even on any given offering. However, by doing these four simple steps, you’ll quickly spot any money leaks that could be draining your profits, and you can take the proper steps to ensure your business stays on track.

And who knows…you may even discover that a service or product you don’t enjoy offering isn’t making you money. Then you can reasonably discontinue that service or product and focus your business on those things you do enjoy and profit from. So get in the habit of calculating the indirect costs of doing business and allocate those costs to everything you do. By tracking the numbers in this manner, your bottom line will grow.

For more on business costs see Entrepreneur  https://www.entrepreneur.com/encyclopedia/operating-expenses#

Marsha Lindquist