One of the hardest things in any business is working out how to price your goods or services. There are many different ways to price, which really merit their own series of posts.
For this post I’m going to assume you’ve bought supplies, made some products, sold them, paid your overheads, and now you have enough information to work out your actual profit margin.
The formula is:
Net Profit = Revenue – All Costs
“Costs” here means all your costs: the cost of the materials that went into the products you sold, plus things like insurance, rent, website hosting, etc.
If your profit is positive (above £0), you’ve made a profit for that period. If it’s negative (below £0), you’ve made a loss. You may have made a loss because you didn’t appreciate all your costs and so you underpriced your products – but you won’t do that again because now you’re keeping accounts!
Watch my video on this subject here, or read on below:
Gross Profit
Before you started trading, you would have wanted to work out some idea about the cost of the materials you used directly in your product, so that you could come up with a reasonable price for each product. This gives you your Gross Profit. For example, for a decorative cushion:
Gross Profit = Revenue – Direct Costs
= £25 sale price – £10 fabric – £1 zipper
= £14 gross profit
But now that you have started trading, you’ll have a better handle on your overheads, which are the difference between your Gross Profit and your Net Profit:
Net Profit = Gross Profit – Overheads
So let’s carry on with our example. Let’s say you, our cushion maker, have now sold 100 cushions at £25 in your first month. We know that comes to £1400 in Gross profit, but after we take account of all the overheads, have you made a net profit? Let’s find out.
The first thing we might notice is that you used more than £1000 of fabric (£10 per cushion times 100 cushions). You would have had scraps and waste – pieces too small to use in the pattern; pieces where the sewing machine tension was wrong and you ended up with a mess; etc. (Hopefully not too much of this latter. This is part of why I could never sell my own sewing.) Let’s say you used £1100 of fabric for those 100 cushions.
The next thing we might notice is that you bought £2000 of fabric, though you still have £900 worth left, £850 untouched and £50 work in progress. That £900 worth of fabric is an asset in your business, and you shouldn’t count it against the sales you’ve made in month 1 to find out how profitable your business has been so far. Eventually, you’ll count it as closing stock for the period in question, but just right now you’ll ignore it and focus on the fact that you’ve used £1100 of fabric.
The next thing you’ll look at is your notions and sundries. You’ll want to do a stock take and value what you have left against what you bought in, the same as with the fabric. Zippers, thread, lace, printer paper, notebooks, receipt paper, all of it. Let’s say you work out that you’ve used £150 of sundries including zippers.
Now, since you’ve been keeping accounts, your overheads will be given to you on a report. Let’s say in the past month, you’ve booked 3 market stalls at £50 each, plus paid £50 in Etsy fees, £50 in Paypal fees, £15 for your website hosting, £1 for this month’s portion of your website domain name (at £12/year), £20 for your business insurance, £15 in mileage for going to the markets and the post office, £100 in postage of items you sold online, £4 for a Linktree subscription for your Instagram account, and £4 for your monthly Google Workspace fee for your business email.
All those overheads come to £409 for the first month. I’m assuming that you started up with whatever sewing machines you already owned, you’re paying no rent, and you’re not VAT-registered.
Net Profit
So now what’s your Net Profit?
Net Profit = Revenue – Costs
= £2500 sales – £1100 fabric – £150 sundries – £409 overheads
= £841 net profit this month
So you can see that the £1400 gross profit we started with became £841 of actual net profit – this is the money you can use to pay yourself, buy more fabric, etc.
Later on, you’ll also want to account for income tax (or corporation tax if you’re a limited company). Once you earn a profit above the Personal Allowance (which is currently £12,570, but could be increased or reduced by things like Marriage Allowance and Blind Person’s Allowance), you’ll be liable for at least 20% income tax. At that point, your Net Profit becomes £672.80 for the month.
Only once you can work out this figure can you work out whether you’re making any profit, let alone enough profit to want to carry on.
If you only worked 10 hours that month to make that £672.80, then you averaged £67/hour of profit: that’s fantastic, and you clearly are on to a great thing.
If, however, you worked 35 hours a week for 4 weeks, so 140 hours that month, then you averaged only £4.80/hour of profit. If that’s the case, then you’ll see that this is unsustainable (and indeed, below the National Living Wage for anyone over age 21), and you’ll need to adjust something. We’ll look at some options for that in the next post.
There’s quite a difference between knowing you made £6.72 in net profit per cushion and £14 in gross profit, which will impact many of your decisions.
If you consider later whether to rent a shop, you’ll know that it’s lowering that £6.72 even further, so you’ll want to calculate the increased sales needed to make it profitable to have a shop. If, for example, your shop rent plus increased business insurance, utilities, etc, would come to £1200 per month, then you’d need to sell 179 more cushions per month to pay for that. Then you’d be able to weigh up if you think that having a shop would enable you to sell 279 cushions per month (about 13.1 per day), or if you might want to develop further products first.
If you only knew the gross profit figure of £14 per cushion, you’d possibly miscalculate (£1200 / £14) that you needed to sell 86 more cushions per month, so 186 instead of 279. That comes to about 7.3 per day, which is less than one an hour – that might seem more do-able than two per hour, so you might sign a lease on a shop thinking you needed fewer sales than you really did, which could cause you quite a bit of stress later, and possibly the death of your business.
Having the right figures to hand, and knowing how to use them, is ultimately why we keep accounts for our business.