Key Takeaways
Understand how rising costs are affecting your margins and how long your business can absorb them.
Calculate what your prices need to cover, factoring in your costs, overhead, profit goals and what customers expect to pay.
Run different pricing scenarios to see how absorbing, sharing or passing on higher costs could affect your profit.
Explore other ways to protect your margins and consider how customers may respond before raising your prices.
Raising prices is rarely an easy decision. After all, your customers are likely feeling the pinch too, and you don’t want to give them a reason to shop elsewhere. But tariffs, trade uncertainty and higher input costs have become an ongoing part of running a business, and many owners have been absorbing those costs for some time. And let’s face it: there’s a limit to how long any business can do that.
If you’re weighing the decision, you’re not alone. A recent Bank of Canada Business Outlook Survey found that considerably more businesses expected their selling prices to increase compared with the previous quarter.
As you evaluate whether a price increase makes sense for your business, these three steps can help you understand the trade-offs and make a more informed decision.
Step 1: Look at your cash flow
When you absorb a cost increase, it comes out of your margin, reducing the cash your business has available to pay suppliers, cover payroll and handle the unexpected. Tighter margins may be manageable for a while, but over time, they can erode your reserves – and a slow season or large invoice may become difficult to cover.
While you may feel uneasy about raising prices, consider the situation from your customers’ perspective. People who value your products, your service and your relationship with them want you to be around next year and the year after that. A modest, clearly explained price increase may be easier for them to accept than losing a business they count on. And research has shown that Canadians are willing to pay more to support businesses close to home: a study by BDC found that nearly six in 10 consumers are willing to pay a premium for local, provincial or Canadian-made products.
Calculation: How long can you absorb rising costs?
Estimate how many months your cash reserves could cover a monthly shortfall if nothing else changes.
Cash runway (months) = available cash reserves ÷ monthly cash shortfall
Example: If higher costs mean $5,000 more is going out each month than is coming in, and you have $40,000 in reserves, you have about eight months of cash runway. This assumes all other factors remain consistent – a seasonal dip or a late-paying customer would shorten this timeline.
Step 2: Calculate your baseline pricing
Before you decide whether to change your prices, it’s important to know what your prices need to cover. Here’s how to determine that.
1. Work out your fixed costs and profit target
First, calculate the cost of your overhead. These are the fixed costs you pay every month, regardless of your level of sales, such as your lease or mortgage payments, wages and salaries, utilities and the salary you draw from your business. Then, add the profit you’d like to earn for the year to get your overhead-plus-profit amount.
2. Choose a pricing method
The right method depends on what you sell and how your business earns revenue. Common approaches include:
Cost-plus pricing: Calculate the direct cost of producing or buying a product or service, then add an amount or percentage to cover overhead and profit. Check the result against what customers are willing to pay and what the market supports.
Markup and margin: For a retailer or wholesaler, markup and margin describe different things. If you buy an item for $100 and sell it for $150, the markup is 50 per cent. The gross margin is about 33 per cent, because the $50 gross profit is divided by the $150 selling price.
Hourly rate: If your business is service-based and you charge per hour, work backwards from the revenue your business needs to generate and the realistic number of billable hours available. Remember that not every working hour can be billed to a client, so use your past billing history to set a realistic target.
3. Compare your pricing with the market
Your target price also needs to make sense in your market. Research what comparable businesses charge, what customers expect to pay and how competitors differentiate their offers. Then decide where you want to fall within that range – and whether your product, service or customer experience supports that position.
Step 3: Run a profit scenario
When input costs are changing, it can be difficult to see exactly how absorbing – or passing on – an increase will affect your bottom line. Running a few scenarios can make the situation clearer.
Imagine a business that sells 10,000 units a year at $50 each. Each unit costs $30 to make or buy, and annual overhead is $160,000. Before costs rise, gross profit is $200,000 and profit after overhead is $40,000.
Now assume tariffs and higher shipping costs raise the cost of each unit by 10 per cent, to $33. Here’s how three sample scenarios could play out, assuming customers buy a little less as prices rise.
Sample scenario: What happens when unit costs rise 10 per cent?
| Absorb the full increase | Share the increase | Pass on the full increase | |
|---|---|---|---|
| Cost increase passed on to customers | $0 | $1.50 | $3 |
| Price per unit | $50 | $51.50 | $53 |
| Gross profit per unit | $17 | $18.50 | $20 |
| Units sold | 10,000 | 9,800 (-2%) | 9,500 (-5%) |
| Gross profit | $170,000 | $181,300 | $190,000 |
| Profit after overhead | $10,000 | $21,300 | $30,000 |
Using these assumptions, absorbing the full increase preserves sales volume but reduces annual profit from $40,000 to $10,000. Passing on the full increase produces the highest profit of the three scenarios, despite the projected five per cent decline in units sold.
Your own numbers will of course be different. Try several what-if versions using your actual costs, prices and realistic range of customer responses to see the impact of various pricing moves.
Calculation: How much would you need to raise your price?
To keep the same dollar gross profit on each sale:
New price = current price + increase in unit cost
In the sample scenario: $50 + $3 = $53
Passing on the dollar increase maintains gross profit per unit, but not the original gross margin percentage. To maintain the same margin:
New price = new unit cost ÷ (1 – current gross margin)
In the sample scenario, the original gross margin was 40 per cent: $33 ÷ 0.60 = $55
Running your own numbers can help you see how much of a cost increase you may be able to absorb, how much you may need to pass on and what each option could mean for the long-term sustainability of your business.
Before you make a change: 3 final questions to consider
If you’re still considering revisiting your pricing strategy after taking these steps, ask yourself these questions before changing any price tags.
1. Have you explored other ways to offset higher costs?
There are a number of ways to generate revenue — and chances are, they’re not all currently in play. Is there more you can do to offset higher costs or strengthen revenue? Here are some ideas:
Move away from a one-price-fits-all approach. Consider surcharges and fees for rush delivery or orders below a minimum quantity.
Adjust your product design. Tweak materials, packaging or product features in response to higher costs while keeping the quality and functionality your customers expect.
Review your suppliers and sourcing. Changing suppliers, adjusting order volumes or sourcing more inputs domestically may offset some tariff-related costs.
If you don’t sell online yet, consider adding an online store to reach more customers.
If you’re already online, use digital tools and advertising to drive more traffic.
Consider new revenue models such as subscriptions, licensing, franchising or paid workshops.
2. Can you differentiate your business beyond price?
Consumer studies repeatedly show how buyers will switch brands following bad customer service — and how a great experience builds loyalty.
If you can offer something above and beyond what competitors provide, you may be able to attract more customers and earn more revenue without raising prices.
Some ideas include:
Personalize your marketing and customer interactions so customers feel a real connection to your business.
Make it easy to do business with you, with a flexible return policy and fast delivery.
Share your expertise with customers through advice, guides or workshops.
If your products are made or sourced in Canada, make that clear on your packaging, website and signage.
Let customers know how you give back, whether through charitable donations, sustainable packaging or community programs.
3. What are the trade-offs of raising your prices?
There can be consequences to both raising your prices and leaving them unchanged. Raising prices may mean losing some sales, while holding them steady may reduce margin and cash flow. Understanding how your customers might react to a price increase can help you weigh your options. Are your customers particularly price-sensitive? Are they facing higher prices in other areas of their lives? Are they likely to buy elsewhere if you raise your prices? And how long can your cash flow support your current prices?
If you do decide to raise your prices, these tips can help:
Communicate clearly to customers when new prices are in effect, and give them plenty of notice.
Consider smaller, staged increases instead of one large jump.
For loyal or high-volume customers, consider volume discounts or other pricing structures before applying the same increase across the board.
Explain why. If tariffs have increased your material costs by 20 per cent, sharing that helps customers understand the change.
Consider a temporary surcharge tied to a specific cost, such as tariffs or fuel, that you can remove if that cost goes away.
Bottom line
Getting your pricing right is central to the ongoing health and resilience of your business. Absorbing higher costs may make sense for a while, but if that strategy is steadily reducing your margins and your cash reserves, it may be time to revisit your prices. Run the numbers, consider other ways to protect your margins and think about how your customers are likely to respond. The right decision balances financial sustainability, competitiveness and the customer relationships you have worked hard to build.
This article is intended as general information only and is not to be relied upon as constituting legal, financial or other professional advice. A professional advisor should be consulted regarding your specific situation. Information presented is believed to be factual and up-to-date but we do not guarantee its accuracy and it should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the authors as of the date of publication and are subject to change. No endorsement of any third parties or their advice, opinions, information, products or services is expressly given or implied by Royal Bank of Canada or any of its affiliates.
