How to Manage Costs, Pricing, and Profitability as a Small Business

Published by BradyRenner CPAs | September 13, 2023

Budget and financial planning concept involving a management or executive CFO creating or confirming the company's annual income and cost estimate. Annual strategic plan and corporate finance

Running a small business requires business owners to wear many hats and oversee activities in multiple departments. Chief among these responsibilities is managing the various costs associated with operating a successful business in today’s economy. While the task may seem daunting, there are several ways to streamline the process so you are not spending too much time managing costs rather than focusing on other important aspects of your business.

Using Cost Management Plans

For each project your company wishes to pursue, a cost management plan is an essential tool for staying on budget. Planning allows you to work out in advance the expenses and resources necessary for project completion, as well as the most cost-effective way to use them. A cost management plan is not fixed, and may be adjusted as the project progresses, but planning is essential in order to keep those adjustments minimal.

A cost management plan should include:

  • Units of measurement set by you to ensure clear communications of calculations
  • Performance measurement to track progress and set objectives 
  • Control thresholds to give your budget wiggle room – and set a predetermined amount at which a budget excess will trigger reassessment
  • Levels of precision to set your project’s expectations for any variance in measurement
  • Levels of accuracy to measure variances in percentages 
  • Reporting formats to set expectations for how often you wish to see progress reports as well as what those reports should contain

The Importance of Profitability Analysis 

Ultimately, being profitable is what drives your business. There are five different profitability ratios to consider in order to attract more investors and assess your ability to generate income.

These profitability ratios are: 

  • Gross profit margin: the profits left after subtracting the cost of goods sold (COGS); usually expressed as a percentage
  • Net profit margin: calculated by deducting all of your company’s expenses from its total revenue; considered the most important metric
  • Return on equity: measures the efficiency of the company’s profitability by dividing net income by its shareholders’ equity
  • Returns on capital employed: measures how much profit results from the capital employed, which is the total amount of assets after subtracting any current liabilities
  • Return on assets: divides a company’s annual net income by its total assets to assess a business’s ability to use assets to generate profit

Used together, profitability ratios can paint a picture of a company’s ability to use its assets to create profit as well as value for its shareholders.

Pricing Strategies for Success

Pricing your products and services is not a simple task. There are a variety of pricing strategies depending on your needs and goals that you can mix and match:

  • Competition-based pricing involves pricing your products or services below your competitors.
  • Cost-plus pricing works for product pricing and entails adding a fixed profit percentage to the cost of production.
  • Dynamic pricing allows your prices to fluctuate depending on demand. Airline tickets are an example of dynamic pricing, as they change frequently, even for the same flight. 
  • High-low pricing is when a company sells the product for a higher price initially and then lowers the price as it becomes less popular. Think sales racks or deep discounts on holiday-related products.
  • Penetration pricing is practiced by new companies who enter the market and immediately offer much lower prices. This strategy may garner business initially, but a company will eventually need to raise its prices while at the same time retaining their customers.
  • Skimming pricing means having high prices that gradually decrease over time as a product loses popularity. Technology is often priced in this manner.
  • Value-based pricing is set based on the profile of your customer. Prices vary according to constant review of your buyer personas.
  • Psychological pricing relies heavily on your marketing and uses psychological factors to appeal to your customers through everything from font to product placement.
  • Geographical pricing involves setting different prices based on geographic location due to differences in cost of living. 

Break Even Analysis as a Tool 

A break even analysis is a safety measure to determine how much of a product or service you would need to sell in order to cover fixed business costs. This analysis is one of the tools used to help manage your company’s finances and even inform pricing of products and services. 

BradyRenner CPAs Are Ready to Help

Using our suite of financial services, BradyRenner guides small business owners through the life of your small business, from its inception until your exit strategy is implemented. We are your go-to resource for all four of these essential financial analysis areas. Our consulting services encapsulate these analyses as well as regular accounting, bookkeeping and tax services. BradyRenner’s combined decades of experience make us a one-stop shop for small businesses looking to thrive and scale. 

If you would like to learn more about our financial services, please contact BradyRenner today. And make sure to come back for our next article which will examine bank financing as an important step for small businesses.