Pricing for Profit: A Small Business Guide

Plenty of businesses set prices by looking across the street. The competitor charges $45, so you charge $45, and if the month works out you assume the price was right. Sometimes it was. Other times the business has been selling at a thin margin for years, because no one ever sat down and built the price from the cost up.

Pricing is one of the few levers that moves profit immediately and requires no new customers. A one-point improvement in margin on every sale falls straight to the bottom line. This guide explains the difference between markup and margin, how to calculate a price that covers true costs, how to price services where time is the main input and how to test a change. For tax or accounting treatment, check with your CPA.

Markup versus margin

Markup is the amount you add on top of cost, expressed as a percentage of cost. Margin is the portion of the selling price that is profit, expressed as a percentage of price. The same sale produces a different number depending on which you calculate.

Take an item that costs you $60 and sells for $100. The markup is 66.7 percent ($40 divided by $60). The gross margin is 40 percent ($40 divided by $100). If you decide you want a 40 percent margin and apply a 40 percent markup, you will price at $84 and earn only a 28.6 percent margin. That mistake is among the most common pricing errors in small business.

Know your true cost

A price must cover more than the invoice from the supplier. For products, that means the cost of goods sold, including freight in, packaging, payment processing fees and shrinkage from waste or theft. For services, it includes the labor hours, materials, vehicle time and any subcontractors the job requires.

Then there are overheads: rent, insurance, software, administration and your own salary. Overheads do not change much with each sale, but they must be paid out of the margin your sales produce. A common approach is to estimate overhead per billable hour or per unit and make sure the price covers it plus a target profit.

Pricing a product, step by step

Here is a straightforward method for a product business:

1. Add up all direct costs per unit, including shipping in, packaging and payment fees.
2. Decide the gross margin you need to cover overhead and profit, based on your own numbers.
3. Divide cost by one minus the margin. For a $60 cost and a 40 percent margin target, the price is $60 divided by 0.60, or $100.
4. Compare the result to the market. If it is far above, look for cost savings or a differentiation story rather than simply cutting the price.
5. Review quarterly, since costs drift.

Pricing a service

Services hide their costs in time. Suppose you run a cleaning or repair business and want to know your hourly rate. Estimate your annual costs, including your own salary, say $180,000. Estimate the billable hours you can realistically sell, perhaps 1,400 after travel, quotes, admin and slow periods. The break-even rate is about $129 per hour before any profit.

Many owners overestimate billable time, which understates the real hourly rate they need. Build in non-billable hours honestly and add a profit margin on top. Flat-rate or value-based pricing can also work when you are faster than average or deliver an outcome the customer values highly.

Discounts and the sales you need to win back

Discounts feel small and cost a lot. If your gross margin is 30 percent and you give a 10 percent discount, your margin drops to about 22 percent. To earn the same gross profit dollars, you would have to sell roughly 36 percent more units. That math is why discounting rarely pays unless it moves slow stock or brings in repeat customers you would not otherwise win.

Set rules for who may discount and how much, and track discounts as a line item so you can see the cost.

A related trap is the loss leader that never leads anywhere. If a low-priced item is meant to bring in customers, track whether those customers actually buy the higher-margin items. If they do not, you are simply selling below cost to people who would have paid more.

When pricing and financing meet

Financing affects pricing in two ways. First, any repayment obligation is a cost that must be paid out of margin, so a funded expansion that thins your price is not an improvement. Second, if your pricing is too low, the cash it generates may not support the repayments. Always test funding against your actual margin, not your hopeful one.

If you are weighing working capital to grow, Fidelity Funding can connect you with funding partners and a specialist can talk through the options with you. We cannot promise terms, and your CPA is the right person to model the numbers with you, but we can help you find out what is available through a short application and soft credit pull for the initial review.

This article is for general information only and isn’t financial, legal or tax advice. Funding approval, amounts and terms are set by funding partners and depend on underwriting.