Improving your pricing model to be more accurate and predictable is critical to running a successful business.

I worked with a company that claimed to have a good pricing model in place that would generate solid profitability for their business. When I asked to see their company Profit and Loss (P&L) Statement, they showed a much lower Gross Profit Margin and an actual Net Loss. We pulled out non-cash expenses such as Depreciation Expenses to get to their true Operating Profit and they still had a Net Loss.

Why was there a disconnect?

Let’s review five steps to improving your pricing model to deliver the profits you want from your business.

Align Your Pricing Model and Accounting Systems

Start by making sure your pricing model and the Chart of Accounts in your accounting system are aligned. You don’t need every single account in your pricing model but make sure you have the major “buckets” aligned so you can easily record expenses and track progress. You can set up views in your accounting system by jobs, products, customers, location or whatever makes sense to you.

Don’t lump major expense items into one account like Direct Expenses, Overhead or the dreaded “Other Expenses.” For example, break out meaningful Direct Expenses in your pricing model such as materials, direct labor, subcontractors and equipment.

Also, enter your expenses into your accounting system in a timely manner so you can track progress in real-time. Waiting weeks and months makes it hard to make adjustments if needed.

Make Sure Your Pricing Model Includes ALL of Your Expenses

Incorporating all your expenses in your pricing model is extremely important. This includes your direct expenses to produce your product, called your Cost of Goods Sold or COGS. It also includes all your indirect expenses such as facility rent, insurance and equipment financing, along with your overhead expenses such as your office staff and management payroll and benefits. You can allocate these indirect expenses into your pricing model on a pro-rated basis. And don’t forget to include your desired profit product.

Some organizations look at profit as what’s left when everything else is paid for. This is a bad practice that can lead to disappointing results in the long run.

You may need to reexamine all of these expenses on a regular basis because of the high inflationary environment we operate in today. Raw material and transportation expenses may change daily, so you need to review these on a real-time basis and update your pricing model.

Audit Your Pricing Model and Compare to Actual Expenses

Conducting a review or audit of your pricing model on a regular basis is critical to your success. Were your assumptions correct? You may need to account for changes in production or labor hours, cost overruns, change orders and more.

QuickBooks has a Job Profitability Report where you can see all job expenses and compare them to your pricing assumptions, at least at a Gross Profit level. When you find a variance, investigate to see if this was a one-time exception or ongoing change.

Review Your Financial Reports Often

Accurate and timely financial reports can help you assess your performance and identify where to quickly make changes to ensure you generate the overall profitability you expect from your business. Weekly, or at least monthly, reviews will help you stay on top of issues and help you sleep better at night.

Don’t think of this as an income tax exercise. This is an operational review to help you manage your business and gauge your performance.

Use Financial Ratios to Evaluate Your Profit Performance

Financial ratios such as Gross Profit and Net Profit Margins, Liquidity and Accounts Receivable Aging are helpful to evaluate your relative performance within your organization and compare to industry standards. If your profit margins are lower than the industry average, this may be an opportunity to raise your prices.

These five steps will help you keep track of your pricing to ensure you are delivering the profit you want on both a product/job/customer level and across your overall business. The key to improving your pricing model is to keep accurate financial information and review it on a regular basis. This will help you avoid surprises and lead to better profitability.