This is a guest blog post from Howard Polansky of Cash Flow Coach.

Raising your prices is not about greed. It’s also not about inflation, though it does help offset the rising cost of pretty much everything these days.

The true reason to raise prices is two-fold. First, it allows you to work with the people that you prefer to work with because they seem to be the easiest to work with and understand the value you bring to their lives. Second, and more importantly, by weeding out the fringe, you will have more time to think of how to be even more productive without killing the business. Does this sound crazy? I hope so, but I can back this up.

There was a study done several decades ago by Eastman Kodak. Obviously, they didn’t take their own advice as they do not exist anymore, but the study lives in infamy.

Let’s assume your expenses for your business were 75%. That includes the salary, rent, utilities, taxes, etc., and you were able to put 25% into the profit account each and every month. Now, I know that is a bit extreme when one is running their business Profit First style, but most people are not as smart as you to be diligent about every dollar. And to try and get more clients through your doors, you decide to do a “Pick your Holiday” sale.

Using this 25% profit assumption, here’s what the study determined:

• A 3% price decrease requires a 13.6% increase in sales to make the same profit as before the price was lowered
• A 5% price cut requires a 25% increase in sales to achieve the same profit
• A 10% price cut requires a 67% increase in sales to achieve the same profit
• A 15% price cut requires a 150% increase in sales to achieve the same profit
• A 20% price cut requires a 400% increase in sales to achieve the same profit

This sounds crazy, right? But let’s look at the math. If your sales are $100,000 and your overhead is $75,000, you have a $25,000 profit. But we cut our prices by 10%. It doesn’t cut our overhead.

So now you have:
$90,000 – $75,000 = $15,000 profit. To go from $15,000 profit up to $25,000 profit, that’s a 67% difference to the bottom line!! That little bit of a discount at the top of the funnel destroys the profitability of a business, the end of the funnel.

Now, let’s reverse the process and compute how an increase in price would affect profit:

• A 3% price increase means the same profit on 90% of sales volume
• A 5% increase means the same profit on 83.5% of sales volume
• A 10% increase means the same profit on 71.5% of sales volume
• A 15% increase means the same profit on 62.5% of sales volume
• A 20% increase means the same profit on 55.5% of sales volume

If our sales jumped to $110,000 and our overhead remains at $75,000, that is a $35,000 profit. If time was more important than money at this stage of life, you may be content with the $25,000 profit. Hence, you could eliminate 3 out of every 10 clients and be at the same profitability.

Your sequence of thought is this:

• If I could only choose one, do I want greater profit or my time but the same profit?
• If greater profit, how much more profit do I want for next year?
• How many hours do I work per week and how many weeks?
• What price per hour do I have to raise my prices keeping all other things constant?

Hence, if I wanted to increase my profitability $10,000 and I work 40 hours per week for 50 weeks (2,000 hours), I would need to raise my prices $10,000/2,000 hours = $5 per hour.

• If it’s more time, how much time do I want to buy back but keep the same profit?
• How many hours do I work per week and how many weeks?
• What price per hour do I have to raise my prices, keeping my revenue and all other things constant?

I am fine keeping my profitability at $25,000, but want to go from 40 hours per week over 50 weeks down to 32 hours per week. We are going from 40 hours x 50 weeks = 2,000 working hours down to 32 hours x 50 = 1600 hours.

If our 2,000 annual hours produced $100,000 revenue, we charged $50/hour. If we want an extra day off, we now need to take $100,000/1600 hours = $62.50/ hour. Let’s even it up to $65 an hour, a 30% increase. We would have to lose half of our clientele and we can keep the same profit. If you have built a strong foundation with your clients, not only will you not lose half your clients, you’ll end up working less and still making more money.

And that, friends, is what I’d call a big win!