Start with the numbers, not the competition

It is tempting to set your prices by looking at what others charge. But you do not know their costs, their overheads, or their profit margin. They might be making a loss, or they might have a different business model. Pricing from the outside in is a fast route to working hard for very little. Instead, build your price from the inside out. Work out your direct expenses, your overheads, and the margin you need to make a decent living. Then check the market. That way you know your price covers costs and profit before you quote.

Add up your direct expenses first

Direct expenses are the costs that rise every time you make a sale or complete a job. They are the raw materials, the parts, the packaging, the delivery, the payment processing fees, and any directly paid help. If you sell a product, list every component. If you provide a service, list every cost that would not exist if that job did not happen.

• A baker: flour, sugar, eggs, butter, box, label, and the fee your card machine charges.
• A plumber: pipes, fittings, sealant, and the fuel to drive to the site.
• A consultant: any associate you pay to help deliver the project, plus software used only for that client.

Be honest about wastage and returns. If one in ten candles breaks, include that loss. Add a small buffer for supplier price rises. For example, if materials cost £12.50 per unit, packaging is £1.20, and payment fees are £2.00, your direct cost is £15.70. That is your absolute floor. Never quote below it.

Don't forget your overheads

Overheads are the costs you pay whether you sell one item or a hundred. They include rent, business rates, insurance, software subscriptions, accountancy fees, phone and broadband, marketing, and vehicle costs that are not tied to a specific job. Many small business owners forget overheads when pricing. They see a sale that covers materials and think they have made money, but they have not covered the cost of keeping the lights on.

You need to recover overheads through every sale. A simple way is to divide your total annual overheads by the number of sales or billable hours you expect. For example, if your overheads are £24,000 a year and you expect 1,200 billable hours, you need to add £20 per hour to every quote. If you sell 2,000 units, add £12 per unit. This is not profit. It is just keeping your business alive.

Choose a margin that pays you properly

Margin is the profit you keep, expressed as a percentage of the selling price. Markup is different: it is the percentage you add to your costs. A 20% markup on £27.70 gives £33.24. A 20% margin on £27.70 gives £34.63. To get a 20% margin, divide your total cost by 0.8. To get a 30% margin, divide by 0.7. Use this formula:

Selling price = (direct costs + overhead recovery) ÷ (1 - desired margin)

What margin should you aim for? It depends on your sector, but most small businesses need at least 10 to 20 per cent net margin to survive and grow. If you sell wholesale, you need a higher margin because the retailer will take a cut. If you are VAT registered, remember that the VAT you charge is not your money. Do your cost-plus-margin calculation on the net price, then add VAT on top for the customer.

Put it all together: a simple pricing formula

Here is a step-by-step method you can use for any product or service.

• List direct costs per unit or per job. Include wastage and a small buffer.
• Add overhead recovery per unit or per hour. Use your annual overheads divided by expected sales.
• Decide your target margin as a decimal. For 25%, use 0.25.
• Divide total cost by (1 - margin) to get your selling price before VAT.
• Round sensibly to a price that feels natural, such as £12.00 or £34.99.
• Check the market. If your price is far above competitors, look at your costs or your value. If it is far below, you are leaving money on the table.

For example, a candle maker has direct costs of £5.00 per candle. Overheads are £12,000 a year, and they expect to sell 3,000 candles, so overhead recovery is £4.00 per candle. Total cost is £9.00. They want a 25% margin, so they divide £9.00 by 0.75, giving £12.00. They check the market and price at £12.50. That covers costs and gives a profit.

Review your prices when supplier costs change

Your costs will not stay still. Wax goes up, insurance renews higher, delivery charges change. If you set your prices once and never look again, your margin will quietly shrink. Set a review schedule: at least every quarter, or immediately when a key supplier increases prices. Keep a simple spreadsheet of your direct costs and overheads. When a cost rises, recalculate your price. Do not absorb increases forever.

If you need to raise prices for regular customers, give them notice. A short email explaining that supplier costs have risen is usually enough. If you cannot raise prices, look at reducing costs, changing your mix, or finding a cheaper supplier. Review your overheads once a year too. Pricing is not a one-off task. It is a habit that keeps your business healthy.