The importance of Costs calculation
Nowadays, everybody is worried about having the best Marketing Strategy and selling as much as possible.
This is important, of course, but always if you are selling a product with a proper margin, or at least, with a margin at all.
You may think that it is impossible to sell a product without margin, but is extremely common.
Receiving money for a product is not having a margin.
To have a margin is to correctly take into account all the costs involved in the product sold and still have some remaining money.
As a “General rule” (not scientific at all, but it usually works for us):
- If you are sell a product that is not “unique” very well (with good or better competitors) and you don’t fully cover all your expenses, you probably have negative or zero margins.
In a normal and business-healthy situation, practically any sale is made after a “fight” between the company’s salesperson, the manufacturing team and, of course, the client.
- If you have an average product, and your demand is huge: Be careful.
Without a doubt, one of the most important things in a business project is to know your margins perfectly.
You may have the best marketing strategy, the best strategic planning in the world and the personal skills of a Hollywood actor, but if you are selling a product with no margin, you are failing miserably.
And never forget what we said before: the market generally ends up buying the lowest margin product.
Why? Because if you were selling a product with a high margin that was making you rich, then, your neighbor would quit his job tomorrow and start selling that same product…
- After several months, you would have to lower the price to compete, thus having a product with no margin.
Now, we’ll explain a simple but useful approach to Costs:
- Costs per Product.
- Costs per Client.
* You have an open Excel Template with a generic Business Plan that integrates the products’ Costs and Margins we are about to explain, in the “Business Plan Templates” section.
- It explains in a Practical and Useful way how you can categorize Costs, and link them to your Business projections.
- Also, it calculates the Margin per product and Client automatically.
Cost per Product
These costs are simply the manufacturing Costs.
Main factors involved:
Internal capabilities: the means you have to manufacture or develop a product.
- Your expertise.
- The resources (machinery/computers) you have.
- Your financial strength.
External capabilities: everything that doesn’t depend on you.
- Raw material costs.
- Suppliers’ location.
- It affects your Raw materials’ Transportation costs.
By determining which factors affect your Costs the most, you can make better choices in the manufacturing process that lead to higher margins.
Now, we’ll give you a real example that happened to us a few years ago:
Paint Company Example
3 years ago we analyzed an industrial company that employed different pigment formulations to paint a manufactured stone-based product.
After a deep analysis, we suspected that the amount of pigment used in some products was excessive.
Having seen this, we stopped the production (it was a pure manufacturing line) made modifications in the formulations, and checked the results.
The resulting products were almost the same as the originals and overall margins improved from 2% to 16%.
- We told our clients that we made a small modification, and we lowered prices by 3%.
In absolute terms, we had an 11% increase in margins with all the clients happy to have a 3% price reduction.
Costs per Client
These costs are those that vary depending on your clients.
- Transportation costs.
- Different taxes applied (if they are in different countries).
- Any customized characteristic the clients require.
We recommend tracking the price per product & client.
Because each client has different needs and some of them buy products with higher margins than others.
- You have to take care about these clients.
Increasing Margins with Costs Control
There are 3 main ways of increasing your margins by analyzing your costs.
- Sell what is best for you.
- Costs Control.
- Links Sales.
Let’s see them in detail:
1. Sell what is best for you
Sale of high margin products to Clients with a high purchase price.
- It seems obvious but generally, companies don’t control what they are selling and who is buying it.
By simply knowing your costs and margins, you’ll be able to focus on certain clients and/or products, optimizing your overall result.
2. Costs Control
Reducing the costs that you think can be reduced without affecting your final product.
After a detailed costs analysis, it is quite common to realize possible changes in the composition or manufacturing process that could reduce Costs and therefore increase margins.
3. Link Sales
Linking your lower-margin sales to high-margin products.
Imagine that a certain client is very interested in a product whose margin is 1% (very usual) but just a slightly interested in another product whose margin is 15%.
You could tell him:
- “We’ll sell you this product at this price (1% margin) but for each 3 purchases you will have to buy this other at this price (15% margin) because we have to empty our stock“.
You would have a 4,5% margin instead of just a 1% margin.
* Don’t forget visiting the “Business Plan Templates” section and Download the “Costs” Template.
- Usually, the best-sold product is that with lower margins,
- You must know your products’ margins perfectly.
- By studying the costs of your products, you can discover what can be changed to increase your margins.
- By knowing the costs of your products, you can negotiate prices and quantities more effectively with your Clients.
Don’t forget: selling without knowing your costs and margins is like driving blindfolded.