Finances and Taxes

Service Pricing for Beginners (Or Business Owners Who’ve Been Doing It All Wrong)

Andi Smiles Small business financial consultant 
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People are flocking to your website, booking appointments, and gushing to their friends about how amazing you are. But when it comes time to pay the bills there’s NEVER enough. How can you have so many clients yet so little money? The answer could be your pricing.

There’s more to pricing than picking a number out of thin air. Yes, what your colleagues and competitors are doing matters, but what matters more is that your prices are sustainable for your business. Too low and you’ll find yourself in a cash flow crunch—even if you have a waitlist.

The first step to sustainable pricing is getting intentional about your prices. That does mean doing some math, but the tradeoff is more dollars in your bank account. Here’s a step-by-step guide to pricing your services:

Free service pricing calculator for small business owners.

Step 1: Calculate your costs.

Cost of sales (COS) is the costs directly related to the service that you sell. In other words, these are costs that you incur each time you provide a service.

COS and overhead expenses are not the same. Think of it this way. As a photographer, you may need photo editing software to run your business, but this is not a cost you incur every time you work with a client.

The most common COS for service providers is direct labor. That is a person you hire to help you deliver your service. Other types of COS include software, licenses, and assets that you purchase specifically to provide the service. For example:

  • If you’re a photographer, hiring a second shooter for an event
  • If you’re a web developer, hiring a logo designer for your client’s website
  • If you’re a graphic designer, the cost of stock images for a project
  • If you’re a videographer, the license for the music you use
  • If you’re a bookkeeper, the cost of your client’s accounting program subscription

A good rule of thumb is that if the expense can be traced directly back to the delivery of a service you provide, it’s a COS.

Overhead costs are general business expenses that keep your business operational. Regardless of whether you have clients or not, you’ll still incur these costs. Examples are:

  • Rent for your office
  • Software
  • A virtual assistant

Calculating your COS

When pricing your services, you need to know the COS for every service that you sell. If you already know that you don’t have COS then you can skip this step. If you do have COS, keep reading!

For each service you sell, list the COS. At the end, add up your total COS. This is the cost of your service. Here’s an example:

Wedding Day Photography Package
DescriptionTotal Cost
Photography assistant (second shooter)$300
Web hosting for client’s album for 30 days$10
USB stick with photos$10
Total Cost$320

In this example, the cost of the service is $320. That means that, at the bare minimum, the service package must cost $320—just to break even.

Step 2: Determine your overhead percentage.

Now that we’ve covered your costs, it’s time to tackle your operating expenses. The key to sustainable pricing is ensuring that your prices cover your costs AND your operating expenses. If we don’t factor in your operating expenses then your business will not be profitable.

The first step to making sure that your prices cover your operating expenses is to calculate your business’s overhead percentage. Overhead percentage is the percentage of money from your sales that goes towards paying your overhead, or operating, expenses. Eventually, we’ll fold your overhead percentage into your price.

To calculate your overhead percentage you need two numbers:

  • Your annual gross revenue
  • You annual operating expenses (remember, this does NOT include your costs, which we accounted for in Step 1)

The overhead percentage formula is:

Expenses / Gross Sales = X
X * 100 = Overhead Percentage

Let’s go back to our photographer. Their annual revenue is $100,000 and their annual expenses are $30,000.

$30,000 / $100,000 = 0.30
0.30 x 100 = 30%

Their overhead percentage is 30 percent. In other words, 30 percent of their hourly or package rate from each service goes toward covering the operating costs of their business.

Step 3: Determine your rate.

When I say determine your rate, I mean how much do YOU want to get paid. This is not how much you’re getting in paid total. That number will include your costs and overhead expenses.

One mistake I see providers make is treating their price and their rate as the same thing. For example, our photographer wants to get paid $100 per hour, so her price is $100 an hour. Yet a portion of the $100 per hour goes toward her costs and overhead expenses. That means her rate is closer to $70 per hour.

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This is why you set your rate independently from your price. Your rate is the value of your time. How much do YOU want to get paid to perform your service? When determining your rate consider:

  • How long you’ve been in your industry. Generally, the longer you’ve been in your industry, the higher your rate.
  • Specialized skills that you bring to your work. For example, our photographer is a Photoshop wiz, and every bridal portrait looks flawless. This is a skill worth charging more for!
  • Licenses, certifications, or training that you’ve acquired.
  • The rates of your competitors. You want your rate to be competitive with others in your industry.

Be realistic about the number of hours the service will take you. Many service providers underestimate their service hours and realize later that they’re paying themselves $10 an hour! Think through everything you need to do to perform your service and how long it will take you. Include client communication and administrative logistics in your estimate.

Here’s an example:

Wedding Day Photography Package
ActivityHours
Client communication (prep email, week of email, preview shots email, delivery email, write a review email)1.5
Preparation of contract, reviewing client questionnaire 0.5
Second shooter communication0.5
Venue walkthrough (+ commute)2
Day of shooting (+ commute)12
Preview shots editing1
Photo editing6
Album uploading to web hosting platform0.5
Album upload to USB stick0.25
Mailing USB stick0.25
Total Hours24.5

Let’s say our photographer sets a fixed rate of $2,000 for her wedding package. Her hourly rate is:

$2,000 / 24.5 = $81/hr

Earlier we said she wants to get paid $100 per hour. That means a rate of $2,000 isn’t enough. Instead, she needs her package rate to be $2,450.

See why it’s important to check your hourly rate before setting a flat fee?

Step 4: Calculate your price.

Now for the fun stuff—figuring out how much you’re going to charge!

Let’s start with setting a fixed rate price. The first step is to add your costs to your rate. If you don’t have costs you can skip this step. It looks like this:

Costs + Rate = Baseline Fixed Price

The next step is to multiply your baseline price by your overhead percentage to see how much you need to add to the price to cover overhead expenses:

Baseline Fixed Price x Overhead Percentage = Overhead Contribution

The last step is to add your overhead contribution to your baseline price:

Overhead Contribution + Baseline Fixed Price = Final Fixed Price

Let’s go back to our photographer’s Wedding Day Photography Package. First, we’ll calculate her baseline price:

$320 + $2,450 = $2,770

Next, we’ll calculate her overhead contributions based on the 30 percent overhead percentage we calculated in Step 2:

$2,770 x 0.30 = $831

Finally, we’ll calculate her final package price by adding her baseline price to her overhead contribution:

$2,770 + $831 =$3,601

Our photographer needs to charge $3,601 for her Wedding Day Photography Package. Remember, a portion of this revenue goes toward covering her costs and expenses. It looks like this:

Revenue$3,601
Overhead contribution– $831
Costs of Service– $320
Profit  $2,450

Let’s do another example, this time with an hourly rate. The process is pretty much the same except you’ll need to divide your total costs by your estimated hours to calculate your costs per hour. If you don’t have costs, you can skip this step.

Total Costs / Estimated Hours Billed = Costs Per Hour

Then you’ll add the costs per hour to your rate:

Costs Per Hour + Rate = Baseline Hourly Price

From here the process is the same. Here’s what it looks like for our photographer:

$320 / 24.5 = $13.06 (Costs Per Hour)

$100 + $13.06 = $113.06 (Baseline Hourly Price)

$113.06 x 0.30 = $33.92 (Overhead Contribution)

$113.06 + $33.92 = $146.98 (Final Hourly Price)

In this example, our photographer will need to charge $146 per hour, which will likely be rounded up to $150 per hour.

Step 5: Adjust your price.

The very last step is adjusting your prices to meet the needs of the market and your business.

First, see if the price is realistic for your customers and is competitive in your market. For example, if our photographer prices her Wedding Day Photography Package at $3,600 and everyone else sells theirs at $2,500, she’ll need to lower her price. That means that she’ll lower her costs and overhead expenses or reduce her production time by working more efficiently.

Next, ensure that your prices are sustainable for your business. Profit enables you to grow your business, pay off business debts, and it’s what you live off of. You have some profit, but that doesn’t mean you have enough profit.

For example, the profit of the Wedding Day Photography Package is $2,450. Given the hours required for the package, our photographer can only sell two packages a month. That gives her a projected profit of $4,900. But what if she needs to pay herself $4,500 a month and pay $1,000 a month toward business loans? Then she needs to increase her prices to meet these needs.

___________

If your head is spinning from all this math, don’t worry! Our pricing calculator that will handle the math side of pricing your services.

Without formulas and calculations to worry about, you’ll find that intentionally pricing your services is exciting and empowering. Plus your bank account will be crying tears of joy when it’s time to pay your bills.

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This is part two of our small business pricing series in partnership with financial consultant Andi Smiles. See part one to learn how to price your small business productsAnd ask Andi your deepest, darkest money questions here in her Facebook group.

Updated: November 1, 2019

Andi Smiles
Andi Smiles Andi is a small business financial consultant and coach who teaches business owners to take control of their finances. She’s helped hundreds of self-employed folx organize and understand their business finances, while also uncovering their emotional relationship with money.

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