Calculating Service Costs
The price at which you sell your services (and products) has a great impact on your business's profitability. However, it isn't the only factor. Costs are critical, too. A cost is what you pay for something. Depending on the type of business, it could be the wholesale cost of products you sell at retail, the employee costs required to provide a specific service, or the cost of raw materials used in manufacturing.
Cost typically includes more than just the purchase price. For example, a retailer will buy products at cost, then have the products shipped to the store and prepared for sale by an employee. All of these are costs. In selling services, any product costs may be minimal or nonexistent. The preparation of the service is the primary cost of goods sold.
In business, costs are typically segmented based on whether they are fixed or variable. The following further explains calculating business costs.
A fixed cost is one that doesn't change in proportion to business activity. A service provider, retailer, or manufacturer, for example, must pay rent, utility bills, and some salaries regardless of whether sales levels are high or low. Fixed costs are not typically included in the costs of goods sold.
Fixed costs for a consultant include office overhead. Consider that your business has fixed costs that will impact your profitability and pricing.
A variable cost is one that does change in proportion to business activity. Typical variable costs for a business include the cost of goods sold, materials, and production costs. A consultant has variable costs that may include resources required for research. A manufacturer who buys parts only does so as they are needed to make things, hence it is a variable cost and considered part of the costs of goods sold.
Defining variable costs can be tricky for some businesses. The office needs electricity for some lights and security whether or not there are employees present; that's a direct expense. However, Monday morning arrives and the computers are turned on for work; that electricity is a variable expense. Smaller companies don't differentiate, but large companies do. Your consulting service, too, will have some costs that vary directly with services and others that vary only slightly. Tracking both can help you establish your pricing.