Understanding Your Product Costs
In today’s episode: We discuss why it is important that you understand your product costs. Way too many small business owners only know what they sell stuff for and have no clue as to what it costs to produce that product of service. Never mind how it is the key to you getting to $100,000 in profit!
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Episode 57: Understanding Your Product Costs
Welcome back to the Local Small Business Coach Podcast. I am your coach, Tammy Adams.
Today we are going to take a look at why it is important you know your product costs
Hey everyone, how’s it going? Welcome back to the show. I want to say hi to all the new listeners that have been joining us. Hopefully you are liking the show. Don’t forget if you are learning a few things, head on back and listen to some of the past episodes and feel free to shoot me an email at email@example.com and request any topic. My #1 goal is to focus on your needs so I love to hear from you.
So today, I thought we would dive in a little to your product costs. Since you each have different types of businesses, when I say product costs, it might be more like service costs for some of you. Those of you in a service based business, still have product costs so this works for you as well.
Depending on who you ask, you might hear different ways to determine your product costs. Remember, you have two types of costs. One is your product costs and one is your expenses associated with the sales of your product or service. So it is important to know which group to put your various costs into.
Think of your product costs as those costs associated with the direct purchasing, or making of the product or service. All the other costs that have to do with selling your product are more business expenses vs product costs.
Expenses will be advertising your product, vehicles to sell it, etc.
Product costs will be the parts and labor to produce the product or service. Commonly called your costs of goods sold. For example, if you are selling a drink. You will have the cup, the lid, the straw and the soda. If you are making a bicycle then you have the tires, frame, pedals, chain and handlebars.
For a service based business, let’s say you are cleaning a carpet, your costs might be the chemicals you use.
EMPLOYEES – Product Cost or Expense?
Now you might be wondering about your employees and how they fit in to your costs. If your employees are used to assemble the product or do the service then their payroll is part of the costs of goods. In our bicycle example, if it take 30 min to assemble the bike, then you will have say $10 in employee costs as well. So let’s say the parts are $40, you now have $40 in parts, $10 in employee time so your costs are $50 for the bike.
In our carpet cleaning example, you might have $10 in chemicals and 2 hours of employee time so $30 in employee time for a total of $50 here as well for this service.
Now keep in mind, your employees can fall into two different types of buckets. If they are only involved in the selling of the product, then they are an expense. If they are part of the assembling of the product then they are part of the product costs.
DO YOU KNOW YOUR PRODUCT COSTS?
So let me ask you a question, do you know what the costs are for all the products or services that you sell? If you are like most local small business owners, the answer is no. You have all the best intentions but let’s face it, you just haven’t had the time. For others, it might never have occurred to you to even know this information.
If our goal is to get you and your business to $100,000 in profit, then it is critical that you have this information.
You don’t have to memorize this stuff. I recommend that you create a spreadsheet or even a notebook.
WHY IS THIS IMPORTANT?
So, why is this important to know? All the sales in the world do not make a difference if you give it all up in your expenses and product costs. Let’s go back to our two examples. If we know the bicycle costs $50 to make, then you know you need to sell it for more than that to make a profit. Let’s say you want to have a 50% margin, then you know you will want to sell your bike for at least $75.
If you have that carpet cleaning business and your costs run that same $50, then you know a $49,99 special will not get you to your $100,000 in profit, never mind keep you in business long.
I can’t tell you how many small business owners are flying blind on how much profit they will make from any given sale or service they do. Don’t you think it is important to know what you are going to get paid? Just because the customer paid you $100 doesn’t mean you got paid $100. I for one want to know how much I can count on from any given job.
WHAT YOU NEED TO KNOW
Let’s just say you are headed out to replace a hot water heater. You quote the customer $1000. Would you know what you can expect to take home at the end of the job? First you want to add up the parts needed. You purchase the water heater, new lines, new valves, and a few other parts and you are looking at $700. But then you need to add an hourly wage to the time spend installing. If you hire an extra set of hands, don’t forget that as well. So let’s say you have $50 tied up in labor. So at $750 you have $250 in gross profit. From here, you will eventually deduct your other expenses.
Let’s say your monthly expenses run you $2,000. Then at $250 profit, you need at least 8 water heater installs just to break even. Obviously, you will have other things you do as well. So it will be some combination of goods or services sold.
WHAT DO YOU NEED EACH MONTH?
Do you know what you need to sell to break even each month? Do you know the sales needed to cover both your expenses and your product costs? If you don’t, I want to challenge you to create that spreadsheet or grab that notebook and start documenting what your product costs are.
I want you to know what you charge, what the costs are and therefor what your gross profit is. Let’s take that drink earlier. If your cup, lid, straw and soda cost 50 cents and you charge 99cents then you know your gross profit is 49 cents. Even better, you can now project that if you sell 500 drinks, you will make $245 in gross profits (pre expenses).
GET TO $100,000 in PROFITS
You might recall from episodes 3 & 4, that if you are wanting to get to the$100,000 in profit you need to work backwards. I will not rehash those episodes but you can always listen to them plus watch the videos and get the free spreadsheet at the website.
I have watched so many folks think they can grow their profits by just selling more. So they work harder and harder. They work longer and longer chasing sales hoping to make more money. The reality is, you can make more money, more bottom line profits in many ways. One of those ways is to control your product costs. But first you have to know them to control them.
So please, do this not for me but for yourself. Set aside time to know what it costs you to build your products and for any services you offer. It will help get you one step closer to that $100,000 in profits.
And as we wrap up this episode I want you to know, that I realize being a local small business owner can be a lonely gig at times. But you don’t have to do it alone. Just know, I’m always here for you.
By the way, If you like what we are taking about, then make sure to subscribe to the podcast so you don’t miss an episode, if you love the podcast and what we are talking about, then please leave a 5 star review so other local small business owners know this is a podcast that they can’t miss.
And don’t forget to visit the website at LocalSmallBusinessCoach.com to leave your question for me to possibly answer on the podcast in the future. You can leave it via the Speakpipe button or just shoot me an email.
Meanwhile, I wish you the best in your business and remember: Great Customer Service, coupled with Great business practices will set you on the path to Great Profits!
Bye for now…..
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Two Great Books to Help You With Your Small Business:
Highly Recommend all Local Small Business Owners Read the eMyth by Micheal Gerber. You will learn some critical things about running your business.
The second book is one I wrote based off a popular example I always use when folks are trying to understand their role as a leader with their people. Check it out.