Pricing From the Numbers Backward

Part B: Understand the Money

We see this constantly with contractors, cleaners and consultants. They look around, see what the person down the road charges, and pick a number a little below it. Then, a year later, they are busy, tired and somehow not paid. The number was never built from anything. It was borrowed.

There is a better way to start, and it begins at the end. Work out what the business has to earn so you know your floor, then ask what the job is worth to the customer. Your price lives between the two, and the floor tells you when you are giving work away.

Start with what you need to take home

Write down the income you need the business to pay you each month, before anything else. Not what you would like in a perfect year. What you need, and ask your accountant how much to set aside for taxes on top of that, because the number you need to take home is after tax. Many owners skip this number, and it is a big reason prices end up too low: nobody put the owner on the cost list.

Then add the overhead, the costs that arrive whether or not you sell anything. Insurance, software, the phone, the truck payment, advertising, rent if you have it. If the Fixed, Variable and Semi-Variable Expenses lesson is fresh in your mind, this is the fixed side of that list.

Add the two together. That total is the gross profit the business must produce each month, just to keep the lights on and you fed. Gross profit is what is left of a sale after the direct costs of doing that one job, so the next step is to find those.

Then count the cost and the time of one sale

Direct costs are the ones that only exist because you did the job: materials, supplies, a helper’s wages, fuel, a subcontractor. Pick one typical job and list them honestly. Then ask how many hours it really takes, including the drive, the quote, the follow-up and the paperwork. Most of us forget those hours, and they are still hours of our life.

Now the last piece: how many jobs, customers or units can you realistically deliver in a month? Not on your best month. On a normal one. That is your capacity, and it is the number the whole price rests on.

A worked example with made-up numbers

Say, purely as an illustration, that a landscaping business owner needs $5,000 a month to live on, and overhead is $2,000 a month. The business must produce $7,000 of gross profit. Say the owner can deliver 40 jobs in a normal month, and one typical job costs $95 in supplies and helper wages.

• Gross profit needed: $5,000 + $2,000 = $7,000 a month.
• Gross profit needed per job: $7,000 ÷ 40 jobs = $175.
• Price per job: $95 direct cost + $175 = $270.
• Check: 40 jobs × $270 = $10,800 revenue. Less 40 × $95 = $3,800 direct costs, leaves $7,000.

If each job takes three hours of work, that is 120 hours a month, and $270 for three hours is $90 an hour of revenue. The gross margin here is $175 out of $270, a little under 65 percent. None of these figures are a target; they are only a way to show how the arithmetic hangs together. One more trap here: margin is not the same as markup. Markup is the percentage you add on top of your cost, and margin is the share of the price you keep. Say something costs you $100 and you add a 50% markup. The price is $150, but the margin is only 33%, because the $50 you made is a third of $150. Mixing the two up is the classic way owners underprice, since a 50% markup does not give you a 50% margin.

Now compare that price with the market, and this is where the honest questions start. If competitors charge less, are you slower, more expensive to run, or simply not yet worth more in the customer’s eyes? If they charge more, why are you leaving that on the table? A price built from your numbers tells you your floor. What the job is worth to the customer decides how far above it you can go, and the price you sell for is a hundred percent part of your marketing strategy, so set it on purpose. Discounting does not build a valuable brand, it only gives work away.

Keep in mind that this price is a floor, not a ceiling. It makes no allowance for slow months, bad debts, a truck that dies, or a customer who wants a discount. Those need room too. As the Gross Margin Versus Net Margin lesson showed, the gap between the two is where small businesses get hurt.

Run one real job

Open the free Pricing Calculator on the Resources page and fill in one real job: the direct costs, the hours, your monthly overhead, the income you need, and the number of jobs you can deliver. Compare the price it gives you with the price you charge today, then ask what that job is really worth to the customer and whether your price reflects it.

What it costs

About one to two hours, most of it spent finding the real costs of a single job. It costs nothing. It gets slower if you have never tracked your hours or your materials, but that is the useful discovery.