Setting prices for prodjucts and services is one of the biggest decisions a company generally makes. Setting prices too low reduces profit margins even as the company enjoys increased sales. Setting prices too high can make clients seek other sources of products. Achieving the correct price involves more than just guessing, it involves financial analysis, market research, and continual monitoring.
There is a great deal of emphasis in many companies on increasing sales without realizing how profitable they are in terms of financial gains. It is not always the case that sales translate into profit.
This is where virtual CFO services come in handy. While a traditional CFO only records the company's financials, a virtual CFO enables business people to consider their pricing options, analyze their profitability and forecast the financial results of their pricing policies.
How Virtual CFO Services Analyze Whether Your Pricing Is Profitable
The sales or the income received is how many business leaders consider their companies' success. Although the amount of income received is important, profitability factors beyond income greatly contribute to profitability.
A company can receive a good amount of income but end up making little profits because of production cost, labor cost, shipping cost, overhead cost, marketing cost, administration cost and other related expenses.
Virtual CFO services are based on professional financial analyses and not on assumptions. Instead of asking, "Is there an increase in sales?" the professionals ask relevant and deep questions like;
- Are the products making adequate profits?
- Who are the most profitable clients?
- Is the cost of running operations increasing faster than the income?
- Is the pricing increasing as fast as the inflation?
- Are the discounts making the business incur losses?
Answers to these questions can help one know whether the pricing has brought about good finances.
The virtual CFO analyzes several financial statements which include;
- Income statement
- Gross profit statement
- Product profitability statement
- Trends in cost
- Trends in customer purchase
- Sales performance of products/services
Cost-Plus vs. Value-Based Pricing Explained
Different methods are used by businesses in the setting of prices. The two major principles are cost plus pricing and value-based pricing.
Cost Plus Pricing
In cost plus pricing, businesses consider the cost of producing goods or services and add extra costs to ensure profits.
This pricing is simple because pricing starts from the cost incurred.
Benefits of this pricing include:
- Covering operating costs
- Ensuring consistent margins
- Making pricing decisions easy
- Aids budgeting
The disadvantage of this pricing is that it mainly considers the internal costs of production and not external factors like customer satisfaction.
Value-Based Pricing
Value-based pricing focuses on the value the customer is getting rather than on costs of production.
Customers may be willing to pay higher prices for products that they believe:
- Are of better quality
- Provide greater convenience
- Have superior performance
- Offer superior customer service
- Are based on specialized expertise
Instead of considering only their cost, companies consider the value that customers are deriving from their solutions.
Virtual CFOs assist companies in determining the effect of such pricing strategies on long term profitability without suggesting the price levels.
Determining the right pricing strategy is dependent upon the type of market, customers, products, and business goals of the company.
Why Businesses Need Periodic Pricing Reviews
Most companies set prices and forget about them forever after.
However, business circumstances keep changing all the time.
Pricing factors include:
- Inflation
- Labor costs
- Cost of materials
- Transportation costs
- Costs charged by suppliers
- Market competition
- Customer demand
What was a viable pricing strategy two years ago may now hamper the bottom line.
Virtual CFOs advise doing periodic reviews of pricing with the latest financial data available.
Understanding Gross Profit Versus Net Profit
The pricing decision will have an impact on the gross margin as well as the net profit.
The gross margin is concerned with the profit margin after deducting the cost of production.
The net margin is concerned with the profit margin after deducting all the expenses such as:
- Salaries
- Marketing expenses
- Administrative expenses
- Rent
- Insurance
- Technology expenses
- Professional fees
A company may have a good gross margin but poor net margin owing to increasing costs.
Virtual CFOs consider both margins when analyzing pricing.
How Virtual CFO Services Help Businesses Test and Adjust Pricing
Pricing must change as the company grows and evolves.
Instead of going on emotional decisions and acting like others, virtual CFO services assist companies in determining pricing based on financial analysis.
The virtual CFO could consider the following factors when analyzing pricing:
- Past performance of sales
- Demand from customers
- Profits
- Financial market conditions
- Increases in cost
- Efficiency of operation
This enables business owners to see the financial consequences of their pricing decisions even before they implement the changes.
They don't have to assume that higher prices will automatically translate to higher profits.
Other things that could be affected by pricing include:
- Volume of sales
- Customer retention
- Revenue increase
- Capacity of production
- Operating cost
With scenario planning, uncertainties are reduced.
Monitoring Customer Behavior Post-Pricing Adjustments
Decisions regarding pricing should not be limited to the decision itself but extend beyond that.
Monitoring the response of the customer is essential in determining the success of the pricing adjustment.
Some of the key indicators that you need to look at include:
- Volume of sales
- Customer retention
- Value of orders
- Frequency of purchasing
- Increase in revenue
- Customer acquisition
Continuous monitoring allows businesses to make gradual improvements rather than large reactive changes.
Using Financial Data Instead of Assumptions
Intuition is often employed by many companies when it comes to making decisions related to pricing.
Even though experience counts, finance figures give more objectivity.
Virtual CFOs base their decision-making process on:
- Past performance
- Profitability of products
- Buying habits of customers
- Trends in expenses
- Revenue analysis
Identifying Which Products or Services Are Actually Profitable
Not all products play the same role in achieving business success.
There are products that yield large revenues but little profits.
There are other products that yield small revenues, yet they are more profitable.
This is where product profitability analysis becomes useful.
Virtual CFOs conduct profitability analysis for different sections of the company.
These include:
- Revenues of each product
- Direct costs
- Allocation of labor
- Cost of marketing
- Distribution costs
- Requirements of customer services
In essence, this is aimed at identifying which products contribute to the growth of the business.
Why Revenue Alone Can Be Misleading
Businesses might concentrate only on their most popular products.
Nevertheless, high income doesn't necessarily equal high profit.
For instance:
The product that requires much assistance, expensive shipping and pricey materials can have great income but bring small profits.
In the meantime, the product that has low sales volume may require less investment and be much more profitable.
Virtual CFOs can help you see the difference.
The data is useful for proper resource allocation and long-term planning.
Analysis of Services' Profitability
Profitability analysis also works for service-based companies.
Various services might have different requirements concerning:
- Staff hours
- Professionalism
- Technology
- Administration
- Client interaction
This information helps you understand what services are more or less profitable.
Virtual CFOs look through financial statements to find out which services provide better contribution to the profit of your business.
Supporting Smarter Business Decisions
After the profitability analysis is done, you can make more informed decisions about:
- Business development
- Resource allocation
- Priorities of marketing and advertising
- Staffing
- Improvement of operations
- Investments
Instead of taking into account sales figures only, you can see the financial situation clearer.
How Pricing Decisions Affect Cash Flow
Besides affecting profits, pricing impacts the cash flow of the company.
Cash shortages can be experienced even in profitable companies if the pricing does not match business operations.
The professional services provided by virtual CFOs analyze how the pricing will affect revenue and the availability of cash.
Some of the factors that can be affected by the pricing include:
- The payment terms of customers
- Working capital
- Capital invested in inventories
- Operating expenses
- Collections cycle
The Connection Between Pricing and Working Capital
Working capital is the money that the company uses in conducting its operations.
Poor pricing strategies could lead to less availability of money in the following ways:
- Decreasing the profit margin
- Increasing the financing needs
- Increasing the collections period
- Decreasing the flexibility of operations
Forecasting the Financial Impact of Pricing Decisions
One of the major benefits of virtual CFO assistance is forecasting.
Instead of having to wait for the financial consequences after the pricing strategy change has been implemented, the virtual CFOs perform pricing strategy analysis with what kind of consequences it will have in advance.
The following factors are taken into account during the forecasting process:
- Predicted income
- Cost trends
- Growth of sales
- Demand for customers
- Projected cash flow
Why Pricing Strategy Should Support Long-Term Growth
Pricing is not only aimed at increasing immediate income.
It also has to contribute to achieving other business objectives, like:
- Profitability
- Customer retention
- Positioning in the market
- Efficiency
- Stability
The Value of Ongoing Financial Leadership
It would be difficult to find an instance where a decision on pricing has been taken in isolation.
As firms mature, there will be various interrelationships between pricing and other areas of finance including budgeting, forecasting, investments, and profitability management.
Virtual CFOs ensure continual financial leadership in the process of helping businesses:
- Track financial performance
- Evaluate pricing decisions
- Analyze profitability
- Predict future growth
- Improve financial decision-making
In fact, pricing is one of the main determinants of success of any firm but at the same time one of the most under-reviewed. Firms that depend solely on sales might miss out on decreasing profitability, growing operating costs, or changed customer behavior.
Professional virtual CFO services provided by The Fino Partners can help firms assess pricing using financial analysis, profitability assessment, forecasting, and planning. Knowing the basics like cost-plus pricing, value-based pricing, and product profitability analysis will give business owners a much better understanding of how their pricing affects profitability and cash flows.
Firms can make pricing decisions on the basis of real information instead of assumptions or competitors' moves.
