Along with material and labor costs, it's important to also try and factor in your overheads to your pricing calculations so that you can be sure you are covering all of your costs.
So what are "overheads"? They are essentially any costs that are not directly related to the creation of your products. Some common examples of overheads are phone, electricity, rent and machine maintainance - none of these costs can be connected with any of the products you make, so you consider them to be an "overhead" of running your business.
As overheads don't get tallied per product, they are almost impossible to factor into your pricing with the same accuracy as your material costs, so you'll want to instead aim for a good "guestimate" of your costs and then create a formula that tries to fairly incorporate a proportion of these costs into each of your products. There are a couple of common approaches that you can use, so it's just a case of finding the one that works best for your product range.
You'll firstly want to tally all indirect (i.e. non production) costs that you incurred in the last financial year to give you your total annual overhead cost. Tip: if you use a good bookkeeping program like Craftybase, you'll be able to generate this quite easily from your reports section by selecting the previous years date range.
Once you have this figure, you can now decide how to best spread this cost out over your products.
If your sales are fairly consistent from year to year, you could firstly try to calculate the overhead amount using last year's sales figures. If you sold 2500 items last year and had an overhead of $10,000 then your overhead per product would have been:
Last Year's Overhead ÷ Last Year's Sales = Last Year's Overhead per Sale
$10,000 ÷ 2500 = $4.
If you are anticipating roughly the same amount of overhead expenditure and sales for this year, then it may be reasonable to ensure that an overhead of $4 is included in each product you sell.
If you are experiencing growth in your business, you might like to modify the above formula and use your last year's sales to estimate your likely sales for this year. Say you are growing 10% a year, then if you sold 2500 items last year then you might like to increase this in your calculations to 2750. Hopefully, your overheads are not increasing at the same rate as your sales, so let's say that they only rise by 5% to an estimate of $10,500 for the coming year. The calculation for your overheads, including anticipated growth would therefore be:
Total Projected Overhead ÷ Total Projected Sales = Overhead per Sale
$10,500 ÷ 2750 = $3.81
Percentage based overheads
If your product range substantially varies by price, then using a fixed cost approach to your overheads may not be the best approach for you as you'll be increasing your base cost for all products equally. Although it may not be an issue to increase a $2400 product by $4 to ensure overheads are included, this will have a much bigger impact on your $8 items. To get around this, you can instead calculate your overheads as a percentage of the base cost to produce each product.
This method is less accruate, as you'll be deciding on a percentage to apply to each product based on what feels right. Running these percentages against your previous year's sales to see what total overhead it generates can be a good idea to see if you are on the right track. To do this, you'll need a list of all sales along with the material cost of each item sold (if you are using Craftybase, you can create this view by exporting your order line items for 1st Jan - 31 Dec of the previous year). Open this file in your spreadsheet program and add an extra column to this using a formula to calculate your estimated overhead from the percentage you have chosen. As an example:
|Date||Item Sold||Cost to Produce||Overhead Percentage||Overhead|
|1 Jan||Apple Skirt||$16.56||10%||$1.656|
From here, you'll want to tally the Overhead column to see how this compares to your total overhead costs from the previous year. If it isn't close enough, adjust the percentage calculation and repeat if necessary.
Once you have a percentage in mind, you can now use this to recalculate your product prices to ensure that you are maintaining your desired profit margins. Our blog post here will show you how to do this in more detail: How to calculate pricing markups for your handmade products »
For either approach, you might like to make this more granular and group together your products first before running your overhead calculations - this can be useful if you'd like to apply more of an overhead markup to one group of products over another. Another option again is to apply a lower overall business overhead to all products and then customised overhead markups on your individual products.
Whatever path you do choose, the important thing to keep in mind is that you are factoring in some consideration to your business overhead expenses. The more costs you factor into your pricing, the better your margins will become and the healthier your handmade business will be!