Anne Havel, a former accountant and Chief Financial Officer, is writing as a Guest Author for ASK Harriete. In this third post she continues to apply her financial experience to help artists and makers price their work. Read the previous two posts as prerequisites for this post.
After reviewing the previous post, use the same example numbers to make a couple of simple calculations.
First, let's calculate two percentages and then apply these to pricing work. Take note that we are calculating percentages of target revenue:
Direct Materials ($10,000/$80,000) is 12.5% of the revenue target.
Indirect costs (indirect materials at $5,000 + overhead at $15,000) is $20,000.
And indirect costs ($20,000/$80,000) are 25% of the revenue target.
That's it. Now, let's apply this information.
If we are making a piece and the direct materials cost $50, what should the selling price be?
Many people think it costs them $50 to make it, so anything slightly over $50 would make a profit -- but that is a huge fallacy. As calculated above, direct materials are only 12.5% of the revenue target. Over the course of a year, indirect costs accumulate and must be covered in the selling price. And your personal expenses need to be factored in, as well. So let's use a little of the algebra we learned in high school.
Direct materials are 12.5% (calculated above) of the revenue target. Use the equation: 12.5% of X = $50 and solve for the selling price "X." So, the piece needs to sell for $400 wholesale.
Wow! The math is simple, we just need the right numbers.
Make the formula work for you.
Use your tax return to obtain your personal numbers and calculate your own percentages and use the formula.
FROM THE PEN OF Harriete:
Thank you Anne for your insights. This certainly highlights how underpricing can be avoided with some simple math. It is very important to understand how to arrive at a realistic pricing structure so you know if you are making money.
While, the example is illustrative don't forget that Anne Havel arrived at the wholesale price which now needs to be doubled (or more) for a retail price.
It also assumes that everything made during the year is sold during the year to generate sufficient income. Unfortunately, most of us are not selling everything we make in the current economy. We might have to increase the amount of time in promotion and marketing (which increases our Overhead Labor), and making more work or making work faster is not going to give us revenue if it doesn't sell.