As with all things in life, there are costs associated with doing business. What some business owners fail to realise is the many definitions of cost, and how this will impact both how you may price a product or service, or whether in fact you would look to proceed with a transaction at all. Determining a price by under cutting a competitor is a strategy we frequently hear – but it is generally not a good one without a firm understanding of your cost base.
The total cost of a good / service is a combination of fixed costs and variable costs. Variable costs are costs that change in proportion to output – for example, buying larger quantities of an item generally results in a lower unit cost, as the setup for production only has to be incurred once, and is therefore spread over multiple items.
When putting a price to a good / service, you must consider the cost of:
- labour (including payroll tax, superannuation, workcover, etc)
- inputs (including shipping, duties/taxes, warehousing)
- processing (capital cost, depreciation, maintenance, energy)
- marketing (online, print media, direct mail, sales staff)
- overheads (rent, insurance, registration)
A thorough understanding of these costs will result in a price that has margin accurately calculated; this means no surprises!
Some other common terms in relation to cost worth knowing are as follows:
Sunk Cost: these are costs that have already been incurred and therefore cannot be recovered. For example, if you have purchased a vehicle for the business, regardless of whether you take on any work or not, the cost has been incurred
Opportunity Cost: this refers to the cost of not doing something. This does not necessarily have to be monetary – the cost of not taking on a marginal job for a large client may be the relationship, or potentially a subsequent larger / more profitable job. Or it may be lost revenue / profit from not having the capacity to take on a job
This is where finance comes in to play.
Whilst some businesses may lack the security to obtain traditional bank finance backed by property, there are other unsecured options available. As long as the cost of finance is less than the margin in the job, there is a financial opportunity cost. In some cases, it may strategically make sense to run a job at break even, if there is a relationship or further work to be had. When there are fixed costs such as an employed workforce, often during lean times it is better to run at break even or a slight loss, than to not take on a job and incur a larger loss due to the businesses fixed costs.
If you are looking to capitalise on opportunities, but lack the working capital to do so, contact one of the team at Flexible Capital today to discuss your options.
