The cost of everything is going up. When wages, inflation, interest rates are increasing what does this mean to your profit and what do you need to increase your prices by just to make the same profit?
In this video you'll find out how to work it out for your business;
Hey team Nathan Watt from Watson & Watt in today's video i just wanted to talk about your pricing and specifically what should you do with your pricing when everything else in the world is going up so we've got inflation going up, interest rates going up, we've got wages going up, what does all that mean for you and your business and what does it mean for your pricing?
So one way to do it would just be to guess. Inflation's five percent let's put our prices up five percent but is that realistic and is that the right number to get the answer that you want?
One way - a better way to do that would be to look at the numbers and it doesn't have to be complicated so in this this little summary I've got here, just a quick little excel that you can pull together I'll show you how to work it out.
So let's have a look at this. So let's assume in 2021 financial year this business did a million dollars in sales has a 30% cost a good sales line. $300,000 in wages some superannuation there overheads like accounting fees, rent, insurance, all that sort of stuff gives them a nice profit there are of $200,000 good one.
Now in 2022 inflation data has come out recently as a 5.1% annualized inflation rate so what does that mean if you haven't increased your prices?
It means your stock has gone up by 5% or $15,000.
It means your wages which gone up by 2.4% in the last year have gone up another $7,000.
Super's gone up a bit more than that because of a change in the legislation. Last year it was 9.5% of your salaries this year it's 10% - so obviously we're multiplying a bigger percentage by a bigger base so we're getting this large increase here in superannuation.
And your other expenses have gone up as well - accounting fees just don't quit am i right?
So here we go so if you haven't done anything about your pricing in the last year you're probably taking a bit of a pay cut doing the same amount of work for less money. It doesn't sound like a lot of fun to me so how do we know how much to increase our price?
If we just use a little bit of excel wizardry we can say well we need to increase our prices by $33,000 to get there but what does that mean?
Just jump into here into this one here I'm going to set our net profit line to $200,000 by changing our sales. So our sales need to increase by 3.35% just to get us back to the same profit figure as last year.
Now an interesting thing on this is that $200,000 profit this year doesn't buy as much as $200,000 profit last year because of inflation so if you take this out and pay your mortgage in school fees and groceries and all that sort of stuff you'll be able to buy less.
If you keep some of this in your business to reinvest it into more stock into more equipment all that sort of stuff you'll have less buying power so what we need to do is adjust this figure by 5.1% which is the inflation figure which is $210,200.
So again, what do our sales need to increase by so that we have the same buying power this year as we did last year?
Our sales need to actually go up by 4.37%.
Now, this is only part of the story. This is only catching up from the last 12 months worth of increases in everything.
What does it mean going forward?
Well if we have a look at another future year and let's just put this back to a million - I was playing with this earlier - if you haven't done anything about your pricing yet - so you're still sitting at a million bucks in sales, and we estimate our inflation for the next 12 months at 3%,
I don't know what it's going to be. The crystal ball doesn't tell me, but I know the RBA is trying to keep inflation within the band of 2% to 3% and I think it would be a bad move by them if they completely squashed inflation and got it back down to 2% too quickly that'll stop the economy before it gets started, so i think they'll try to keep it at that higher end so let's just assume it's 3%.
Where are wages going? I don't know.. 2.4% again that sounds okay.
You might be thinking well my wages have gone up way more than that and that's probably true so whatever your wages growth has gone up put that number in but that's lets just use 2.4% because that's what the stats have come out from the ABS so let's have a look here.
If you haven't done anything and you're not going to do anything your wages are going to go up by another $7,000, your super is going to keep growing your other expenses are going to keep going, all of a sudden your $500,000 in overheads are now $531,000
Your gross profit has also taken a massive hit here of 25 grand so you can see here that you're losing hand over fist. You're losing you know 56 grand on last year's profit essentially by not doing anything.
So what do we need to increase our pricing by just to get back to where we were or keep us where we are?
So goal seek again, we're going to set our profit to $200,000. Again, this is just the nominal amount I'm going to show you what the differences are here. So if we just wanted to make $200,000 profit like we were last year we need to increase our prices by another 1.22%.
Let me just put that back we would need to increase our prices by 5.64% to cover off on the anticipated growth in wages and inflation for the coming 12 months - so to be ahead of the curve you would need to put your prices up 5.64% just to get to a $200,000 profit.
Now as I said before, you'll have had two years worth of inflation here so you won't have the same buying power you'll have way less buying power here so let's look at this.
It would be another $216,000 so let's change this sorry let me change that and then we're going to change this one as well.
So we need to put our prices up another 2.8% in addition to the 4.3% we calculated before. So in total your sales would need to increase by 7.17% or 7.2% just to get to the same buying power in your profit as you did last year.
Now this is just to keep standing still. That’s not growing profit this is not doing anything else like that that's just standing still.
So you need to be looking at this for you for your own business you need to get your numbers out.
Go to your profit and loss statement summarize this down and build a little model like this and work out where you're going otherwise put your finger in the air see which way the wind is blowing and put your prices up that way. I know which one I'm going to be doing and if you want to actually use data to make smarter business decisions this is how you do it