“This week’s Ask Manny question comes from Marie.”
It’s getting more and more expensive to run my business. Costs are increasing all the time. Materials are getting more expensive. Employees are asking for higher salaries. How do I keep up with all of these increasing costs and still have enough profit left to pay myself?
Things will get more expensive over time. This is what we call “inflation.” It is a natural phenomenon and is to be expected.
What you need to do is stay ahead of the curve when it comes to inflationary pressures. You do this by periodically increasing your pricing.
Think about it. Why are your costs increasing? Because your suppliers, your vendors, and your employees are increasing their prices. They are demanding more money for the things that they supply to you. Likewise, you are supplying products and services to others, and now you need to demand more money for these products and services that you are supplying. Your customers will now experience a cost increase and, in turn, demand a higher price to keep up. And such is the natural cycle of inflation.
So, to keep your profit margin adequate and to continue to pay yourself an adequate salary, you need to increase your prices. How do you do this?
Step One: You need to assess what your updated costs are. Take your Profit & Loss Statement (“P&L”) and increase each of your expense line items for what they are now going to be. For example, if your salary costs increased by $10,000, then take your P&L and increase your labor expense line by $10,000.
Step Two: Now that you have a P&L that reflects your new cost structure, the next step is to look at your updated bottom line. What does your profit now look like? If you are not generating a minimum of 10% (before taxes), then you are not generating enough profit. FYI, this profit should factor in the salary that you pay yourself. Make sure that you bake your salary into the P&L, and then see what your updated profit is. If it’s less than 10%, then you need to increase your profit. Of course you can do this by decreasing your costs, but for purposes of this discussion, let’s stick with the strategy of increasing your prices.
Step Three: Now it’s just a matter of playing around with your revenue numbers in your P&L. What would your bottom-line profit look like if you increased your prices by $1, for example? Remember that, for every increase in prices, there may be a decrease in the quantity of your product or service sold – that’s generally how the laws of economics work. Make sure you take that into consideration. For example, if you’re a law firm, and you bill your clients hourly, you may increase the bill rate of your attorneys by $20 per hour. This may result in clients asking for less work, and hence less billable hours per attorney. But hopefully your overall billable amounts will increase because of the increased rates. If you are a cafe and increase the price of a coffee by $1, you may sell less cups of coffee, but hopefully earn more overall revenue due to the increased price per cup. Play around with different price increases and consider how it impacts your overall revenue.
Step Four: With every price increase, examine how it impacts your bottom-line profit. Keep going until you hit the sweet spot – a minimum of 10% profit. Once you get to that magic number, you know what your new prices need to look like.
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