Determining Your Overhead – Handmade Item Pricing

In another HandmadeMarketing.org article, Simone Walsh, jewelry seller from the website SimoneWalsh, walked readers through how to determine their wages in order to price their handmade items correctly.

Next, Simone shared her tips for performing a breakeven analysis for handmade product businesses.  Simone also documents these tips in a recent article on her website.

“A major step towards realistic and professional pricing is to do a ‘breakeven analysis’ for your business. This will give you a big picture view as to how you need to price your work in order to make ends meet – and hopefully more,” she writes in her website article.

Simone explains that many handmade sellers forget some of the hidden costs of business.  “The one thing that so many design/craft pricing methods seem to forget is that your business must cover all of its costs – not just materials and labor. Every tool you use, every advertisement you buy, every business card you have printed, etc. must ultimately be paid for by your business,” she writes.

Simone explains that proper item pricing depends on these costs.  A handmade seller needs to know what these costs are and how they at least should be impacting upon an item’s price point.

To determine this “cost of business”, Simone suggests step one is to determine overheads.  “Make a list of all of the overhead costs which must be covered by your business, and calculate them out into annual figures,” she suggests.

Simone says these overhead costs should not include costs relating to the cost of individual sales, such as materials, your labor, shipping costs you charge to customers, etc.  “Your overheads are all the other costs that cannot so easily be accounted for in pricing for individual items,” she tells readers.

To help readers brainstorm overhead costs, Simone suggests the following could be included:

* Wages.  See Simone’s previous HandmadeMarketing.org article about determining wages.

* Rent/mortgage. “Perhaps a portion if you are working from home – or none if your personal income covers this – it’s up to you,” she writes.

* Electricity.

* Subscriptions and memberships.

* Advertising.

* Printing.

* Office supplies.

* Internet connection.

* Phone charges.

* Travel expenses.

* Depreciation of tools & equipment.  “If you need to replace your computer every three years and it’s an essential business tool, put in a third of its replacement value,” Simone explains.

* Insurance.

* Postage (which is not paid for as part of a sale).

* Accounting fees.

* Exhibition costs.

* Research and development.

Simone says the next step is to determine profit/contingency.  “Profit – beyond the wages you have already calculated – is an important element of growing your business and I strongly recommend coming up with a figure to add in to your calculations,” she suggests.  “A profit figure will also help you to have room for error if anything goes wrong with your other calculations, so you can also think of this figure as a contingency. It could go towards covering missing deliveries, breakages, unexpected fees, etc. We all need some room to move when things go wrong or change, as they invariably do, so be sure to factor this room in.”

Simone tells readers to add the final figure of the annual overheads cost to the additional profit/contingency figure which you would like your business to make as a minimum on an annual basis.  “You’ll now use this final figure to come up with a margin to add to your item costs,” she explains.

The next step is to determine the margin required to break even on your small business.  “To earn enough to pay for your business overheads plus profit/contingency figure, you need to determine a margin percentage to add to the costs (labor plus materials) of every item you sell,” she explains to readers.

Simone says if a handmade seller does not add a margin, there’s no way they will be covering basic operating overheads, let alone making any profit.

“To begin with, give yourself a profit margin of 50% just to get your calculations started. Divide your total overheads plus profit/contingency figure by this percentage to determine the total value of annual sales you must make simply in order to cover your costs and make some profit,” Simone says.

Simone gives an example to help explain how to determine the margin required to break event.  “Don’t worry if your figures are wildly different either way – they will be different for everyone,” she tells readers.

* Overheads: $15,000

* Profit: $5,000

* Overheads + profit (total amount needed in addition to labor and materials) = $20,000

* Margin chosen to be added to labour and materials costs per item to cover this figure: 50%

* Divide $20,000 by 50% = $40,000

Simone explains that in this example, the total sales value needed in order purely to cover $20,000 overheads and profit is $40,000, with the extra $20,000 covering the seller’s materials and labor.

“To help make more sense of this,” Simone explains, “let’s say the average wholesale price of your items is $20.00: $40,000 divided by $20.00 = 2000. This means you have to sell 2000 items per year at your average wholesale price simply to break even and make some profit. That’s around thirty-eight items sold every week of the year. Does this sound reasonable based on what you do and your capacity to make and sell items?“

“If not, go back and do the same calculations, but this time look at increased margins – 60%, 70% … all the way to 100% and beyond. Note the different outcomes as to how much less you have to sell in terms of volume to break even as you increase this margin.”

Simone assures HandmadeMarketing.org that sellers will find this exercise to be a very enlightening, whatever margin sellers eventually settle on.

The next step Simone recommends is determining wholesale and retail pricing.  “Once you’ve settled on a profit margin that you’re happy with which will cover your overhead costs and some profit, you should then regard this margin as the lowest you will sell for,” she writes.  “In other words, this should be you minimum wholesale margin.”

Once you have determined that figure, Simone suggests adding at least another 50% of margin to reach your minimum retail price.

“This might seem scary, but it is realistic: your wholesale prices must cover your overheads, labor and materials. And your retail prices should aim to be about double the wholesale amount so that there is room for the retailer to make profit,” she says.

Overwhelmed?  Simone says this process can all seem a bit complex and daunting, but in practice it’s not.

“The hardest part is getting the figures nutted out to begin with and from there it’s just a matter of putting it all into practice and updating it occasionally (ideally annually),” she writes.  “Best of all, you can feel confident that your pricing is reflecting the true costs of running your business and the true income you need it to bring in. That’s a lot better than doing materials + labor x 2, hoping for the best and probably coming nowhere near!“

Simone says it’s a great idea to create a working spreadsheet to help with calculating pricing.  “Learn how to do so if you don’t know already. You’ll find it will make your life considerably easier,” she suggests.

To get started, Simone suggests keeping track of the costs of your materials and labor for every handmade item you make, whether finished pieces or components.  Keep in mind the labor rate can be determined by using the calculations in Simone’s previous HandmadeMarketing.org article.

“Add these two costs together for one item you make and you have your base cost for an item,” Simone says. “Next, add in the overheads margin.  You then need to add on the total overheads margin you have decided upon (see above) to come up with your wholesale prices.  From there you need to add the additional margin for your retail price – remembering to add any sales tax if appropriate.”

This figure will give you your minimum selling amounts for both scenarios.  “Don’t forget to also take into account any other per sale costs which are not paid for separately such as selling fees, etc.,” Simone says.

So what does this final number tell handmade sellers?  “You can make a judgment about what people will actually pay for each item or ‘what the market will bear’.  Generally speaking it should be no less than the minimum figures you have come up with, unless you feel any lost margin on one item will be made up by other items which you can sell for a higher margin than your minimum,” she says.  “Flexibility is good!“

“It’s also a great idea to round out your figures to whole dollar amounts to make them more ‘attractive’, especially for retail prices,” she writes.

What if you determine your final figure for your handmade items is too expensive for the market?

“If you honestly don’t believe that the market will bear the price you’ve come up with for an item based on the above method, then a serious step back is required,” Simone says.  She recommends asking yourself the following questions:

* Are you being realistic? Maybe the market really will pay what your item is worth. Make sure it’s not just yourself who is under-valuing your work!

* Is there any way you can streamline your costs and labor?

* Is this particular item simply never going to sell for the price it needs to in order to pay for itself and your costs? If so, should you try something else?

The next step is to make adjustments where needed.  “Keep an eye on your overheads and materials costs as time goes by. Of course you can go back at any point to revisit and adjust your calculations.  It’s a great idea to schedule time to do this at least once a year to make sure you’re still on track,” she recommends.

Have you taken these steps suggested by Simone?  What were your results?  How did you make adjustments where needed?

Share your thoughts with HandmadeMarketing.org by commenting on this post, or telling us more detail under our “Join” tab.  If our editors like your ideas, we’ll publish your tips in a future article (and link to your handmade shop!)