Kitchen & Bath Design News

AUG 2013

Kitchen & Bath Design News is the industry's leading business, design and product resource for the kitchen and bath trade.

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Business Management { Bruce Kelleran, CKD, CPA } Setting Your Pricing To Make a Proft To price projects in a way that will ensure you are proftable, it's important to understand the diference between pricing and cost, as well as the variables that impact your bottom line. W hen it comes to r unning your kitchen and bath frm, one of the most important things you need to do is calculate pricing in a way that ensures your projects will be proftable. There are two primary ways to approach project pricing: Cost Plus (where you negotiate specifc markups with a client for work to be done) and Fixed Price (where the price of the project is set, subject to changes to project scope). In either case, it's necessary to generate a certain amount of gross proft or margin to cover your frm's general overhead and operating expenses. This month, we'll start with a discussion of how to divide up your costs between fxed costs and variable costs. FIXED OR VARIABLE Any discussion of fxed and variable costs must begin by acknowledging that there are few totally fixed or totally variable costs. Rather, we defne a fxed cost as one that will remain the same month to month over the short to medium term. Examples of such fixed costs would be building rent, utility bills and ofce staf. Variable costs are generally those that are associated with production of a company's product – in our case, a remodeling project. Such costs include job labor, job materials and subcontractor costs. A lt hough selling expenses and commissions are often seen as part of the office staff costs, they are usually variable costs, since most salespeople are paid a commission based on a per- centage of the sales price of our projects. Once we have identified our fixed costs, we can perform some calculations to determine what sales volume we will need to cover these. This is referred to as a "break-even" point: the amount of sales required to just cover fxed costs. MARK-UP AND MARGIN When product is sold, the first element to identify is the direct cost of the product. If we sell one more item of a particular product, what is the cost of acquiring that product? In most instances, this will consist of the price we pay our supplier, plus the cost of having the product shipped to us. The diference between this cost and the price we charge our customer for the product is our gross proft, or gross margin. If our cost of a product is $100 and we sell it for $150, there is a $50 gross margin. Let's pause here to make sure that we clarify the difference between mark-up and margin. We can look at our example below to help us clarify the diference between the two: Sell Price $150 100% Cost 100 67% Gross Margin $ 50 33% Mark-up, on the other hand, is an expression of the relationship of sell price to the cost we have paid for a product. In this case, we would use a mark-up of 50% on our $100 cost to determine a sell price of $150. The danger comes if someone 18 | Kitchen & Bath Design News August 2013 setting pricing knows that the company guideline is to maintain a 33% gross proft and then marks up cost by 33% instead of 50%. CALCULATING YOUR BREAK-EVEN POINT Let's begin by creating an example of a medium-size remodeling business. Ofce staf $145,000 Occupancy costs (Rent, Utilities, etc.) $320,000 Other Administrative Expenses $225,000 TOTAL FIXED GENERAL EXPENSES $690,000 Now that we have identified our fixed costs, it's possible to determine what our total sales volume must be at va r ious assumed margins (gross profit percentages) to just break even. Several factors will go into coming up with the necessary gross proft percentage. The competition will infuence the prices you are able to charge, along with the law of supply and demand, and that means you can likely sell more at a lower price. Remember, too, that the margin (gross proft) must cover your sales commissions. If we assume a gross proft percentage of 45%, we can determine the break-even point by dividing the fxed cost total by 0.45. So we can see that sales of $1,533,333 would yield $690,000 of gross profit. Likewise, the markup required on our costs to achieve a 45% gross proft can be calculated using the formula: 1 / (1-.45) = 1.81818. Using this information we can do some "what if " scenarios to see what happens when you feel that a price reduction is necessary to beat the competition or help sell that really big job. If we reduce our sales price by 10%, it reduces our gross proft from 45% to 35% and will raise our break-even point over $400,000 to $1,971,428. If you're convinced that lowering prices will generate enough additional volume to produce the required gross proft, then it might be worth considering. Keep in mind, however, that this increased volume may cause some of your "fxed" costs to creep up, i.e. more ofce help, additional equipment, etc. sensitive to our customer than if they were buying a product such as a refrigerator, where they could make an apples-to-apples comparison of prices. We cannot ignore the necessity of controlling overhead costs. While we may have a good deal of leeway in pricing, containing our costs will increase our bottom line proft and allow us to increase margins without having to raise prices. We should not ignore the fact that there are competitors who will work hard at controlling their cost of doing business. One consideration that does not lend itself to a calculation is just how large an organization you want your company to become. More sales volume will normally generate more gross proft, but it will also lead to more employees, more equipment "Understanding the relationship between mark-up, margin, overhead and break-even will allow you to manage your selling strategy in order to maximize proft." SOME LESSONS Understanding the relationship between mark-up, margin, overhead and breakeven will allow you to manage your selling strategy in order to maximize proft. Too often, the focus within a business is on the raw sales volume that the business is doing instead of the proftability such sales produce. Keep in mind that a big part of what we are selling is our unique design abilities and the expertise our frm can bring to a customer's project. The cost of a project is therefore much less price and separation of duties and responsibilities. In developing your sales and pricing strategy, you need to consider how large and complex an organization you want to have. Make sure that everyone within your business understands the relationship between pricing and cost. In most of our businesses, nearly everyone will be involved at some level in setting the pricing on contracts, products or change orders. You don't want them using your company's target margin percentage as the mark-up when they price these. Read past columns and features and send us your comments about this article and others by logging onto our Web site: www.ForResidentialPros.com

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