# Calculating Your Net Cost Per Sale

Updated January 1, 1 . AmFam Team

If you’re a startup or an established business updating your pricing strategy, here are some tips on how to analyze the cost of your products or services to maximize profit.

The primary reason you started a business was to turn a profit, right? Of course. But in order to make money, it’s critical that you understand your service cost and its effect on pricing. If you’re a startup or an established business updating your pricing strategy, here are some tips on how to analyze the cost of your products or services to maximize profit.

“It’s really important for businesses, especially in their early stages, to focus on profitability and know their cost structure,” says Marie Driscoll, CFA at Driscoll Advisors (Opens in a new tab). “You can’t just follow your dream. You also have to look at the nuts and bolts of the business.”

Driscoll and Dominique Broadway, CEO and personal finance coach at Finances Demystified (Opens in a new tab), provide these steps to help you calculate your net cost per sale.

Step 1: Calculate total cost. Add up all costs incurred to produce the product or service – materials; labor; salaries and benefits; and overhead costs (both fixed and variable) such as rent, marketing, website maintenance, shipping, etc.

The goal is to make a profit, but you also want to ensure that you can cover your operating expenses, says Driscoll. Small business owners often fail to take into account items such as marketing, loans and money for expansion. That can all affect the price point you decide on.

“The easiest way to keep track of your expenses is to keep a spreadsheet and update it weekly,” says Driscoll. “There are plenty of templates both free and at a cost that you can use. Check out SCORE (Opens in a new tab) for a free version.”

Step 2: Calculate total sales. Total sales are your unit price times the amount of units sold. For example, if you charge \$10 for a widget and sold 5,000 widgets, your total sales is \$50,000 (\$10 X 5,000 widgets).

Step 3: Divide your total cost by total sales. This is your net cost per sale. After calculating your net cost per sale you’ll be able to determine if you are pricing your products or services for profitability or if you’ll need to adjust the sell price based on your cost.

## How to Improve Your Net Cost

Conduct market research: “Shop around and see if there is anyone else that offers the same materials at a cheaper cost, but without sacrificing quality,” Broadway suggests.

Reduce marketing spend: Marketing and advertising often take up a large portion of a businesses’ budget. If that’s the case, Driscoll says, “use social media and other low-cost marketing and advertising options until you have the revenue to hire a marketing and/or sales team.”

Raise your prices: “If you can’t reduce your cost or find the materials you need at a lower rate, you may have to increase your prices,” Broadway says. But before you raise your prices, check out your competitors. “See what other people are charging so that you don’t price yourself out,” she adds.

Reduce staff: “For seasoned businesses, when sales start to flounder you can cut back by removing staff that are a part of your overhead expenses, “Driscoll recommends.

Don’t just get into business with a goal to break even, strive to be profitable and prosperous. “Anytime you are about to sell a new item, you need to determine the exact net cost of that item before you start pricing it to sell to the public,” Broadway says.

# Related Articles

• Avoiding Burnout as a Small Business Owner

• When Should You Invest In Rental Property?

As a landlord, you know that an investment property has great potential. When everything goes according to plan, it can be an exceptional source of income. But seeing a consistent return on investment means you’ve got to keep a close eye on the numbers before you close on a property.

Although there’s a fair amount of risk involved in making a purchase, you can lean on a few key rules, formulas and indicators to help guide your decision. Next time, when you’re wondering “Should you invest in this rental property?” refer to these important purchasing tips to help make the right choice — and quickly rule out real estate that may not be worth the investment.

Answer a simple question: Will your monthly rent for the space equal at least one percent of the purchase price? If your answer is yes, then your place may be able to turn a profit in the years ahead. Congrats, you’re off to a good start. Be sure that the rental’s priced competitively for spaces of similar design. Here are few other factors to consider:

### Understand the formula

If the total purchase price of the property is \$200,000, rent should be no less than \$2,000 per month or one percent of the total cost. Likewise, a \$600,000 purchase price for a multi-unit rental property should meet or exceed \$6,000 per month in total monthly rent earnings.

### Get the purchase price right

When factoring in the purchase price, remember to include closing costs, property taxes and insurance. One way to better estimate these costs is to use an online closing costs calculator which can approximate appraisal fees, home inspection fees, application fees, prepaid interest among a host of other out-of-pocket expenses that can up your purchase price, sometimes by thousands.

### Factor in repair costs now

Because real estate investing as a landlord requires the space to be “habitable” upon tenant occupancy, you may need to make certain repairs or upgrades before renting the property. As a result, you’ll want to add the total cost of these repairs into the purchase price.

## Consider the “Class” of the Neighborhood

Neighborhood classifications help buyers understand the potential return on investment in a given area. If you’re new to being a landlord, you’ve got to pay close attention to what the neighborhood’s telling you.

One good way to check out an area — specifically if it’s an investment that requires some traveling — is to use Google map’s street view. Is trash left out on the front lawn? Do neighbors maintain their property? What can the cars parked on the street tell you about the demographic? Here are details on the four distinct neighborhood classes real estate agents use to classify a region:

### Class A neighborhoods

High income neighborhoods, combined with a home that is move-in ready will usually get an A class rating. Because homes are expensive in these neighborhoods, and their higher than average tax burden, real estate investors usually won’t buy a home there because the one percent rule fails the test. Tenants in these areas tend to be very reliable, high-quality renters.

### Class B neighborhoods

Typically populated by those earning a moderate-to-high income, B class neighborhoods are frequently considered a good investment for landlords and fertile ground for tenants seeking rentals. Purchasing “as is” properties that can be cheaply updated and rented above the one percent factor is typically possible here with minimal risk. These areas will usually experience increased turnover and vacancy rates.

### Class C neighborhoods

Because the risk is a little higher in neighborhoods that land in the C class category, the opportunity to see a high rate of return on fixer-upper places is good if you buy a For Sale by Owner property, or one not listed on the MLS (multi-listing service for real estate sales). Populated with blue collar workers with relatively low-to-average income, C class areas typically have higher crime rates and under-performing schools. Landlords should expect less-than-optimal tenants and periods of vacancy.

### Class D neighborhoods

Areas riddled with crime, properties damaged upon a tenant’s exit and high costs for property upkeep can be anticipated in D class neighborhoods. Buyers usually consider these types of purchases high risk. It should be noted that many property management companies are reluctant to accept properties to service in these areas because the risks associated with the area. Investors tend to seek properties in more stable neighborhoods.

## Use the Capitalization Rate as a Predictor of Value

Another key way of understanding the rate of return on an investment is the capitalization rate or “cap rate” for short.

### What is a cap rate?

A cap rate determines a profit ratio that a property can generate. It’s best used as a quick way to compare investment opportunities to determine which one is the better value. Start by dividing the total of one year’s rent by the current market value of the home which should include costs and upgrades required to get the space habitable — you can’t rent the place if it’s not livable, right? The resulting percentage is your cap rate. The higher the rate, the better your annual profit margin.

## How to Calculate the Cap Rate for an Investment Property

Although the cap rate’s a useful tool to quickly analyze the relative value of comparable real estate opportunities, it’s used as a rough guide to qualify properties for consideration, given the state of today’s current market climate. First, estimate your property’s overall purchase price:

### Figure the acquisition value

Simply put, this is the total purchase price. It should include all upgrade costs, closing costs, taxes, business insurance, fees, points, etc. Let’s assume a property you’re considering has a total purchase value of \$200,000.

### Calculate one year’s rent

If you’re collecting \$2,000 per month, you’ll have twelve payments at the end of the year, or \$24,000. This figure is your gross annual income.

### Account for half a month’s vacancy

Because turnover typically requires some painting and repairs, it’s fair to consider that half a percent (two weeks’ worth of rent) of your total annual income will be deducted to cover the mortgage payments. Assume that your new tenant will cover the remaining pro-rated rent for the other half of that month. Once the vacancy amount is deducted, the result is your gross operating income.

• Gross annual rental income: \$24,000
• Less the cost of vacancy: -\$1,000
• Gross operating income: \$23,000

### Factor in operational costs

These costs will include money required to keep the property habitable, like paying for trash collection, making repairs, fees from property management, and landlord insurance. Let’s put that cost under fifty percent of the gross operating income, or \$9,300. Some years it will be more, some less.

• Gross operating income: \$23,000
• Less operating costs: \$9,300
• Net operating income (NOI): \$13,700

### Divide the NOI by the total value of the property:

\$13,700
---------------------  =  0.0685 or 6.85 % - That's your cap rate.
\$200,000

The capitalization rate for this investment is 6.85 percent annually. If another property under consideration returns a higher cap rate like 8.23 percent for instance, you may want to explore opportunity with the higher annual yield in order to maximize your profit potential.

### What is considered a good cap rate?

Generally, a cap rate between 8% and 12% is considered good. However, an optimal cap rate is really going to depend on several factors including location, risk and current rental income. For example, in high-demand like big cities, a cap rate of 4% may be considered good.

## Reach Out to Your Agent Today

With so many different ways to look at profitability when determining where to invest in rental property, it’s important you do your homework before you decide to buy. And while you’re making that big decision, remember to contact your American Family Insurance agent and discuss your upcoming purchase. When it comes time to close the deal, you’ll have peace of mind that your property’s insured carefully.

• Reduced Business Costs & the Internet of Things

You may have heard the term “Internet of Things” (also known as IOT) buzzing around a lot lately. Catchphrases such as predictive maintenance, retrofitted sensors, and reactive technologies are humming through newsfeeds and making many entrepreneurs curious. But, is it all hype or is there measurable business value in investing in the IOT?

“The Internet of Things is going to be a big thing for small business,” says Tim Reid, a network systems engineer and consultant for private industry and government. Referring to the concept of billions of objects being connected to the Internet, Reid points out that smaller firms will be able to cut costs and become more competitive thanks to the new technology.

While the IOT is not a new concept, it is evolving and becoming more relevant in our everyday lives and the way small businesses get ahead.

A study by logistics service provider DHL and IT firm Cisco predicts that the IOT will save businesses \$1.2 trillion in productivity costs alone.

Are you ready to be one of those businesses? Here are some ways that the IOT can improve your company’s bottom line.

Inventory management. You can keep track of costly inventory – even with it being in a remote location such as a warehouse. With inventory sensors on small items or large products, businesses can reorder stock as it runs low.

Safety compliance. “There are many local, state and federal regulations, but small businesses often don’t have the funds to hire compliance teams internally,” says Reid. IOT allows small businesses to use sensors to measure air quality, temperature, and other conditions that may be governed.

Potential revenue stream. “The big thing about the Internet of Things is that it can be a model for recurring revenue every month,” says Reid. For example, a small business can put sensors on a product that it installs and “offer to monitor it for customers for a monthly fee.”

Security. For years, video surveillance has utilized physical tape that could be removed or damaged. With the IOT, videos are connected to the Internet and can be viewed remotely. “Business owners can track access to their building based on fingerprints and badges. This is inexpensive and easy to implement,” says Reid. Many people are choosing security systems for protection for their small business. From the alarm system to fire, smoke, window and door sensors, you’ll gain peace of mind knowing you’re proactively protecting your business.

Wages and labor savings. If your business monitors or repairs products for customers, the IOT can be revolutionary. Traditionally, companies send out a person to repair a product or resolve an issue on site, which can be costly. With the IOT, data can be sent from the product directly to your company’s computer. You can troubleshoot, rule out problems and make decisions without leaving your office.

Energy management. Gone are the days of the maintenance staff going from room to room and building to building to adjust the thermostat. “It is now connected to sensors that can be controlled remotely,” says Reid. Businesses can save on energy costs by powering down when parts of their facilities are not being used. Nest thermostat is a popular smart device for energy efficiency that can be controlled from your phone no matter how far your business takes you.

“As small businesses continue to look for ways to reduce costs and gain agility, the Internet of Things can potentially level the playing field,” Reid says. “If you pay attention, small businesses can get ahead of larger ones.”

• 14 Tips for Securing Vacant Commercial Property

If you’re a business owner or a commercial real estate landlord, staying in business can be a difficult sometimes. There are a lot of reasons why a commercial operation might need to close for an extended period. And in today’s challenging times, some of those reasons are simply out of your control. If your business has been forced to shut down in response to the COVID-19 pandemic, you may be wondering how to keep your property safe while you’re away.

Protecting your vacant commercial property is all about securing the perimeter. And by installing a smart security system, you can get real-time data on the condition of your business property, whether it’s occupied or not. We’ve put together some tips to help reduce the threat of serious damage to your commercial property if you’ve found yourself temporarily unable to run your business.