Once a company understands how to recover its overhead costs correctly, determines its needed markups, and establishes its competitive profit percentages, it is able to select a pricing method that best fits the way the company does business. There are several pricing alternatives.
Direct Cost Pricing Bases the selling price on the direct costs of materials, labor, and overhead. This method is effective for businesses that have little or no variable overhead and have a full understanding of their costs. Varying profit percentages may then be applied to different components of the cost and a price determined.
Profit Margin Pricing Calculates selling price as a percentage of total costs. It does not use varied profit percentages, choosing instead to sum the entirety of costs associated with producing a product or service and then applying a profit percentage to determine the price.
Time and Materials Pricing Popular with service corporations, this requires that all materials be priced at retail and include related overhead costs and profit margin. It further requires that hourly wage rates include related overhead costs and profit margin. To determine the final price requires only that accurate work records be kept of all materials used on the job and total hours of labor expensed. The time and materials method, with profit already built in, makes it impossible for the horticulturist to lose money on a job unless everything dies, requiring replacement.
Direct Markup Pricing Material and/or labor costs are multiplied by a constant figure to arrive at a price that will cover all associated costs and allow for a profit. For example, a florist may mark up all flowers and other perishable materials from three to five times depending on the location of the shop, season of the year, and volume of business. The same shop may mark up nonperishable items only two times over cost since spoilage is not a problem. Direct markup pricing is common in retail operations but can be imprecise if all costs are not covered. It can also result in overcharging for some items and undercharging for others.
There are many reasons why small businesses fail, but one major reason is that their owners or managers do not keep or properly utilize business records. Records give direction to the operation of a business.
Four basic types of records are kept: sales records, cash receipts, cash expenditures, and accounts receivable. Properly kept, they can provide the owner with insights into monthly sales, cost of sales, payroll, cost efficiency, time requirements for various services, depreciation of fixed assets, operational overhead expenses, and the profitability of specific promotions or services.
Although horticulturists should have an outside accountant prepare all financial statements for the business, they must be able to understand and utilize the reports once they are prepared. There are two parts to a financial statement: a balance sheet and a profit-and-loss statement. Balance sheets show the financial status of the business on the date they are issued. Profit-and-loss statements record how much money the business earned or lost over a period of time (monthly, quarterly, or annually).
Pricing requires careful analysis by the horticulturist to ensure that all costs are accounted for and that the profit allowance is appropriate.
Price = Materials + Labor + Overhead + Profit
Failure to measure any component of the equation accurately will result in a price that is unfair to either the business or the client. Carefully kept records are the key to accurate pricing.
The past year’s records can provide valuable data about the cost of materials, although material costs are variable and change with the amount of sales, market conditions, and wholesale prices. Labor costs are also variable but can be closely estimated if the past year’s records were kept well. Overhead may be fixed or variable and recovers operational costs that are not directly linked with materials or labor. Many companies use a multiple overhead recovery system to ensure that the sectors of the business that create the overhead costs are used to recover those costs.
Profits increase as the sales volume increases, assuming no rise in fixed overhead costs. Profits also increase when the price of the product or service sold increases.
As the number of categories of merchandise, products, and services increases, the calculation of costs becomes more complex. To cope with the problem, some businesses consolidate a variety of different items under a few categories. Each category must have records to show what percentage of total gross sales it accounted for and how many items, hours, or other units were sold in the process.
The final price determination is influenced by competitors’ prices and the return on equity desired or needed. Equity is the dollar amount of assets owned by the business that is not offset by indebtedness. The rate of return on equity is the percentage of the owner’s equity that is returned as net profit during the business year. Using the percent rate of return and the past year’s price figures as guides, pricing for the current year can be developed. Alternative approaches to pricing include direct cost pricing, profit margin pricing, time and materials pricing, and direct markup pricing.
A. SHORT ANSWER
Answer each of the following questions as briefly as possible.
1. List four attributes of a good record system.
2. List the four basic types of records that are kept by a small business.
3. Indicate if the following information is provided by a profit-and-loss statement (A) or a balance sheet (B).
a. shows the financial status of the business on a particular date
b. lists the company’s assets
c. records the amount of money earned or lost over a period of time
d. lists the company’s liabilities
e. itemizes expenses
f. lists the net worth
g. lists the net profit
4. Define the following terms:
a. inventory shrinkage
c. break-even point
5. Complete the following sentences
a. Profits result from __________ sales volume
without _________ fixed overhead costs.
b. The dollar amount of assets owned
by the business that is not offset by indebtedness is termed.
c. The percentage of owner’s equity that
is returned as net profits during the business year is termed.
d. Another term for equity is_____________ .
e. The percentage rate of return on equity
is calculated by dividing the net profit by the.
6. List four different approaches to pricing.
7. Of what value are financial ratios to a business person?
B. PROFIT CALCULATION
If a lawn service company incurred material, labor, and overhead costs of $1700 in servicing a project site and wanted to make a profit of 20 percent on the project, what price would they charge the customer and what would be their actual profit?
Upon completion of this chapter, you should be able to
• discuss the benefits and limitations of modern technology in the green industry.
• explain the major types of computer programs currently popular in the industry.
• explain other technological advances that now serve the industry.
• project future benefits of technology to the industry.
TECHNOLOGY IS DYNAMIC________________________
Technology is not new. It is defined by time. Throughout history, each generation has witnessed distinctive and unprecedented technological breakthroughs thought impossible by earlier generations. The horse and buggy were retired by the horseless carriage. The earthbound passenger train was swept away by the airplane, which has since been surpassed by the gravity-defying rocket. Communications have progressed from jungle drums to wireless cell phones. Entertainment has evolved from parlor games to surround sound home video systems. Only slightly less dramatic has been the transformation of American business. Where there were once labor-intensive offices filled with secretaries, file clerks, accountants, keypunch operators, typewriters, filing cabinets, mimeograph machines, and a computer the size of a refrigerator that hardly anyone knew how to use, there is now something strikingly different. Fewer people, operating fewer machines with expanded capabilities, have brought a new look to the office workplace. The computer is now the central feature of every office and most desktops.
THE BENEFITS AND LIMITATIONS
Like so many advances that preceded it, the computer age has offered many benefits, with a few accompanying drawbacks. Modern computers are much smaller than their first generation ancestors and have
many more capabilities. They can process and store vast amounts of data in a variety of forms. They can accelerate calculations, project the effects of changes, and even predict the changes. They can allow instant recall of historical data, react to sensors, correct spelling and grammar in multiple languages, create graphic illustrations from numerical data, activate environmental systems, turn drawings into electronic impulses, and restructure them as drawings in far distant places. While doing all of these things, computers never show the slightest sign of fatigue, bad temper, or stress. They don’t form labor unions, they don’t go on strike, and they don’t need vacations, holidays, or even coffee breaks.