Have you found yourself in a situation where you’ve finished a job only to discover you’ve only just broken even or perhaps actually lost money due to underquoting?
First of all, don’t beat yourself up. Most small business owners discover at some point, particularly when starting out, that they have underquoted.
Here are some tips to help you avoid underquoting on a job.
Three key considerations to help you prepare a quote
1. Full recovery of the cost of items sold or services provided
This one is straight forward, just ask yourself ‘what is the cost to replace the item I am selling?’ For example, if you’ve sold an item and you are posting it to a customer, recovery costs should include the cost of the item as well as postage, packaging and insurances etc. Your accountant can help you if necessary.
Tip: Many service based businesses are less likely to have a cost of sale component.
2. Contribution to overheads
Overheads are all the other business expenses that are not direct sale replacement costs; examples include rent, wages, motor vehicle costs etc.
If you’re starting out in business, this one may be a little trickier to work out as you may not know all your overheads. If this is the case, download our free operating expenses forecast calculator to help you. If you’re estimating overheads, it’s best to do some research by contacting suppliers rather than just guessing.
Talking to other business owners could provide you with insights. If you’re running an established business, your profit and loss statements or tax return will provide information on the current overhead levels.
3. Contribution to your profit margin
A contribution to your profit margin is a financial return above wages that are paid to yourself and/or any employees.
To do this, you’ll need to make some decisions about:
- how much capital you’re prepared to invest into the business
- the margin of risk you’re willing to work with
- your total number of income producing hours and hourly rate
Knowing this, you can then use the following formula to calculate your hourly rate.
Desired profit amount + desired salary (owner's drawings) + operating costs / number of income producing hours = your hourly rate
For example: A sole trader has invested $50,000 of borrowed capital in the business. They want to make a profit on this money of $6,500 (13 per cent return on the money).
In addition, they want to reduce their debt by repaying the capital over five years. This means they have to reduce the debt by $10,000 per year (this is paid out of profit). So overall, their profit contribution to repay this is $16,500 ($10,000 + $6,500).
The owner now calculates that the business must earn a profit of $100,000 ($10,000 capital repayment + $6,500 profit + $83,500 owner’s drawings (money taken for personal use) = $100,000).
This means the owner must price their hourly rate to achieve a desired net profit of $100,000 per year.
Their business also has an operating cost (overheads) of $30,000 per year.
So, using our formula, their hourly rate is $125 ($130,000/1040 hours= $125).
If you are registered for goods and services tax (GST), you’ll need to add the 10% GST amount to your hourly rate.
What you can do if you’ve underquoted
Like most matters in business, communication is the key. If you’ve underquoted and the quote is in writing you’re required to complete the job at that price. If this has happened, you should let your customer know that the job was underquoted and that you won’t be able to carry out similar work at that price in the future.
If you’re in a situation where you have completed the job and the customer is happy with your work, this can provide you with an opportunity to explore other work which you can carry out for them (think of it as a ‘would you like fries with that?’).
Example: You’re a painter and you have underquoted on a job to paint the interior of a house. On completion of the job, see if there are any opportunities to paint the exterior or whether the customer has other properties that may require your services.
Contact our free business advisory service to ask our experienced business advisers your questions about pricing your services or quoting.
Download our free financial management tools to help you calculate your business costs, forecast your cash flow or cost of goods sold.
Read our financial management information for more tips and guidance on topics such as developing financial processes, providing credit to customers and getting paid on time.