Now that you’ve identified what it costs to start and run your business, you can work out the cost of producing your product or providing your service. This section takes you through the process of costing your product, costing your service or costing for retail.
2. Costing your product or service
In the previous section, you identified all the costs associated with starting and running your business. This included capital costs, as well as fixed and variable costs.
Now you are in a position to work out the cost of producing your product or providing your service.
3. Costing your product
The cost of your product is how much it costs to produce (the raw materials and packaging plus labour) plus a contribution towards the overheads of the business.
Here’s how to calculate that overhead contribution:
- estimate how many products you’ll sell in a year. In this example, 3,000 units.
- work out your total fixed costs - overheads plus drawings. In our example, overheads are £6,000 and drawings are £12,000, so total fixed costs are £18,000.
- divide the total fixed costs (£18,000) by the number of units you expect to sell (3,000) to calculate how much fixed costs to allocate to each unit.
£6,000 + £12,000 = £6
Add the direct costs for that unit to calculate the total product cost per item.
In this example, the direct costs are £3.
£6 + £3 = £9
Here’s the full calculation:
Total Overheads + Drawings £6,000 = £12,000
Total No of Units 3,000 uned
+ Direct Costs (for that product) + £3
Product Cost = £9
Use this template to cost your product (MS Word 12kb).
4. Costing your service
Costing a service works on the same principle as costing a product, but this time takes into account your hourly rate for providing the service.
Here’s how to calculate your hourly cost:
Number of weeks you expect to work during the year (be realistic)46
Number of productive (chargeable) hours you expect to work per week24
Work out your total fixed costs (overheads plus drawings)£21,600
Calculate the annual total of chargeable hours46 X 24 - 1104
Calculate the hourly charge to cover fixed costs21600/1104 = £19.56
Remember to allocate some time to running the business – for administration, marketing, bookkeeping and planning.
This calculation gives you the basic cost per hour for providing your service. You may also need to add in costs for any materials you use or produce, for example, a trainer may produce a workbook or training notes for delegates, or a plumber may provide replacement items such as a washer or pipes.
Here’s the full calculation -
Total Overheads + Drawings £6,000 + £12,000
Productive Hours 1104 Hours
=Hourly Cost £19.56
Use this template to cost your service (MS Word 13kb).
5. Costing for Retail
If your business is involved in buying items to re-sell, you need to establish how much to add to the price you bought the unit for, so that you cover all your costs and make a profit. This is your retail mark-up.
Here’s how to work it out:
In this example, overheads are £9,600, drawings are £12,000 and direct costs are £45,000
Total Overheads + Drawings £9,600 + £12,000
Direct Costs £45,000
= Retail mark up % = Retail mark up of 48%
This means you would increase the amount you paid for the item by 48% to cover your costs and make a profit. If you paid £1 for the item, you would sell it for £1.48.
6. Break-even point
The break-even point is the point at which your costs and your income are equal. Anything you sell above break-even generates profit for you. In your calculations, make sure the figures you estimate for the number of units you will sell, or the number of productive hours you will work, are realistic.
Break-even can be used to help you see the relationship between your price and the number of units sold, as well as the effect of different prices on the business.
Calculating your Break-even point
To calculate your break-even point, you need to know:
- total fixed costs/overheads for the year
- direct costs per unit, and
- expected selling price
Total Fixed Costs - £10,000
Direct Costs per unit - £2
Unit Selling Price - £6
Work out the contribution each unit makes to the total fixed costs by subtracting the direct costs per unit (£2) from the selling price (£6).
Selling Price – Direct Costs per unit £6 - £2 = £4
Now divide the total fixed costs (£10,000) by the contribution (£4). This gives you the number of units you have to sell to break-even.
Fixed Costs = Break-even point : £10,000 = 2,500 units
Unit contribution £4
Calculating your Break-even point
In our example, the business needs to sell 2,500 units to break-even. If they produce more than 2,500 units, they make a profit, less than 2,500 units and they make a loss. The sales forecast needs to be higher than 2,500 units to make a profit.
Break-even Point and Pricing
Using this example, let’s look at how different price points affect the amount of product you need to sell to break-even.
If the selling price is £8 instead of £6 the contribution per unit is now £6 and the break-even point is 1,667 units
£10,000 = 1,667 units
If the selling price is £4 instead of £6
£10,000 = 5,000 units
From this example, you can see how price and sales are linked:
- selling price of £6 means selling 2,500 units to break-even
- selling price of £8 means selling 1,667 units to break-even
- selling price of £4 means selling 5,000 units to break-even
Make sure that if you adjust your selling price, you understand how much you need to sell to break-even.
Break-even point for service businesses
For service businesses, use selling price per hour and subtract any direct costs per hour.
Use this template to calculate break-even point (MS Word 23kb).