In every good pricing formula or tool there’s a spot that says “Overhead”. That one little word probably gets more blank stares than anything else in pricing. It’s relatively easy to figure out what you paid for your materials. You can see and feel and touch them in everything you produce. Not so your overhead. Your overhead is the total of all your indirect costs, everything you purchase of pay for that isn’t directly attributable to a specific piece you produce. It’s what keep the roof over your head, the tools in your hands, and powers your message into the world. You couldn’t survive without what you pay for overhead, but it frequently gets lost in the pricing calculation. Let’s figure out what yours is.
First you’ll need to gather some information:
A list of all your hard costs for the prior full fiscal year, exclusive of your materials. This is everything you spend money on that DOESN’T directly go into a piece:
• Building expenses such as rent, utilities, phones, internet, property insurance, security services. Even if you work out of your home, you will have some expenses. Even if you don’t pay rent, you should figure out the actual cost of the space you occupy for your business, and come up with a per square foot number that accounts for your share of the rent/mortgage, utilities, etc. Again, I don’t care if you actually cut the check or not – what we’re trying to do is get you ready for the day you WILL cut that rent check. Figure out your space, and what it would cost. If you work in the kitchen, use your kitchen’s square footage. Total house square footage, figure your percentage. Take your houses expenses (mortgage, utilities, property taxes, etc) x the pcentage of space you occupy. That’s your “rent”.
• Capital expenditures you made last year on behalf of your business, whether the business paid for it or not. This is stuff like equipment, tools, storage gewgaws, computers, books related to your business, display items, transport items, cases, trays.. you get the idea. (By the way, for costing purposes, we treat this differently than your accountant does for tax purposes. This is not the same as amortization and depreciation.. We need to be sure you have enough cash when your motherboard blows. Your accountant is only trying to appease the IRS)
• Internet and online expenses. Website costs, social media, any little programs you pay for, subscriptions, etc
• Any contractors that aren’t tied to your product, like VA’s, social media folks, developers, graphic artists, etc.
• Photographers, models, stylists, photo shoot expenses
• Advertising & PR – print, postcards, Facebook ads, blogger placement, anything you paid out to promote your business or goods
• All continuing education or coaching you paid for last year. From $10 webinars to $30,000 coaching programs, write them down.
• Professional fees like lawyers and accountants
• Anything else you spent last year that was business related that wasn’t components or inventory, or labor to make the pieces.
ADD UP everything that falls under this big umbrella – this is your total overhead. Keep this number handy, you’re going to need it in a minute.
Let’s say your numbers all total out to $15,000 for the year. Hang onto that.
Now you need your gross sales totals from last year as well. Don’t include freight or sales tax charges in this number, and make sure to account for any returns. We’ll use $125,000 in our example.
Divide your total overhead costs by your sales; then multiply by 100. This will give you your overhead percentage. Here’s what that looks like:
(Overhead/Sales) x 100 = Percentage overhead
($15,000/$125,000) x 100 = 12% Overhead costs
So in our example 12% would be the number we’d use in a spreadsheet when calculating pricing. In other words, you’d add 12% to the cost of each item to account for all those extra expenses, or plug in 12% in the “Overhead” slot in the tool or formula.
What “should” your overhead be? That’s hard to say. Somewhere in the 10% range seems to be about average for a small business without commercial rent. But every area of the country is different, and if you’re in New York City your overhead is going to be a lot higher than a maker in Shawnee, Kansas. That’s why it’s so important to know what yours is and to account for it in your pricing. Just going though this exercise of figuring it out may reveal places where you can cut down and consolidate expenses. Any time you can streamline costs you should, and that includes your overhead – as long as you’re honestly accounting for them in your pricing calculations.
One caveat: If you have any unusually large expenses or purchased that you know won’t be repeated, and that will artificially inflate your overhead percentage, you can spread it out. For example, if you spend $10,000 on a big coaching program that you won’t do every year, or buy a $5,000 computer or piece of equipment that only comes up every once in a while, you can spread these costs out. Decide how often you anticipate incurring those expenses – for example, you want to buy a new piece of equipment every five years, so you account for $1,000 of that expense every year for five years. Just make sure you account for it honestly and logically, and that way when you need to replace it/pay for it again, you’ll have it accounted for in your pricing calculations.
HUGE DISCLAIMER: I’m not an accountant, and you should consult one before making any business decisions that affect your taxes or impact your finances. I’m giving you the way I’ve calculated overhead in the trenches for over 25 years purely to assist in pricing what you make. There are also several other methods accountants use to calculate your overhead, many of which are tied to your labor costs. For a tiny business or a solo operator, those just don’t make sense. I like this one, but it’s certainly not the be-all and end-all. Talk to your accountant if you want to get down & dirty with your overhead costs. It’s a big item that most makers forget to include, and when you pull it all together, a huge part of why so many businesses either fail to launch, or fail completely. However you look at it, you must include it in your pricing.
Now that you have your overhead number, you’re almost ready to begin pricing. You still need to gather up a wee bit of info:
A) A complete and exhaustive list of every component and material you use, along with it’s most current pricing. You’ll also need the most recent set of invoices so you can figure Net Costs inclusive of freight.
B) Your materials breakdown, materials lists, photos, however you keep track of what goes into each piece.
Get that together, and meet me back here next time. And make sure you have fresh batteries!
Need guidance with pricing in your business? Schedule a private session with me, and I’ll help you tame your pricing demons in no time.