One of the main challenges service based business owners have is determining their profitability on a client by client basis. Especially when some of their costs needs to be spread over all of their clients. It’s a calculation the average bear won’t know or understand how to calculate. But it is a necessity, if you want to know how much profit you can make on every client.
For those who do know how to calculate their profitability by client, they are typically only looking at their gross profit. This is when you take your total revenue number and deduct all of your direct costs associated with your sales. That will give you how profitable, or in some cases not profitable, your product or service is.
But I also like to calculate how much net profit I generate per sale. Because you are trying to cover overhead costs, this calculation will tell you how many clients or sales you need to generate a net profit. This is how much income you made or lost in all over the entire company.
Your net profit, or loss, is then determined by taking your gross profit, or loss, and subtracting your overhead expenses. Or what I like to call the costs you must pay to keep the lights on. These expenses are also referred to as your general and administrative expenses.
So for my visual peeps here is what these calculations look like:
Gross Revenue 60,000
Less: Cost of Sales 30,000
Gross Profit (Loss) 30,000
Less: Overhead expenses 20,000
Net Profit (Loss) 10,000
In order to make sure that you have a gross profit and not a gross loss, it’s pretty simple. You take your sales price and subtract your costs and if you end up with a negative then you need to do one of two things – raise your prices or reduce your costs.
But to determine how much of the overhead is covered by each client you need to first figure out what your overhead cost per client is. This is a number you will need to calculate annually since your costs may change. To calculate that take your total expenses for the year and divide it by our total labor. This is your overhead rate. Then take the total overhead expense for the year and divide it by twelve to come up with your average monthly overhead expense. Now take the overhead rate and multiply it by the monthly overhead expense. That is how much of your monthly overhead expenses are. Divide that number by your total number of clients to see how much of the overhead needs to be included in their pricing.
Now you may be saying if I do that my costs increase drastically and I can’t charge customers that. You may be correct. But seeing your shortfall will help you see how many sales you actually need before you do turn a profit. Turning a profit is not always about pricing. Sometimes it’s about volume.