How to Price a Product


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Simple markup

In a retail situation it is usual to add a mark-up to the direct (variable) costs of buying relatively similar goods in order to cover estimated overheads (fixed costs). This markup is then applied to all goods made or purchased.

The steps are:

Estimate direct (variable) costs for the next year

This will involve analysing the quantities of products sold in recent years and estimating the quantity likely to be sold next year (see the Estimating Sales topic). Then allowing for expected prices from suppliers for the coming year, estimate the cost price of this volume of products.

Estimate fixed costs for the next year

Estimating overhead costs will generally involve the following steps:
(a) identify all overhead costs (including owner’s return or profit)
(b) estimate the annual cost for each overhead

Calculate the markup percentage

The products estimates in Step 1 must be sold for the their own cost price plus an extra amount to cover the estimated fixed costs estimated in Step 2. Calculate the fixed costs as a percentage of the product costs, and this is the extra that must be added to each product when sold:

Markup percentage =

Fixed costs
Estimated product costs

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How to Price a Product

  1. 1. Pricing Products
  2. 2. Cost Behaviour1. Direct Labour and Direct Materials are Variable Costs: – Expenses that tend to change in direct proportion to the volume of sales. Generally these will be the costs in preparing goods and services for resale. – For example: raw materials, production wages.2. Overheads and indirect costs are generally Fixed Costs: – Expenses that do not vary (in the short term) with the volume of activity. In the Profit & Loss Statement these will be the Selling, Administration, and Financial Expenses. – For example: rent, management salaries,
  3. 3. 1. Markup on Direct Materials For example in retail… Add a mark-up to the direct costs of making or buying relatively similar goods to cover estimated Overheads. Example: Cost of materials to be sold (or stock purchases) $150,000 Expected wages (if any) 10,000 Estimated overheads for year 14,000 Desired profit for owner 36,000 Total of other costs and overhead to recover… $ 60,000 60,000 Markup required: = 40% 150,000
  4. 4. ExerciseCalculate the required markup percentage:Cost of materials to be sold (or stock purchases) $125,000Expected wages (if any) 25,000Estimated overheads for year 10,000Desired profit for owner 40,000Total of other costs and overhead to recover… $ 75,000 75,000Markup required: = 60% 125,000
  5. 5. Another exerciseCalculate the required markup percentage for each product:Expected wages for staff 30,000Estimated expenses for year 10,000Desired profit for owner 50,000Total overheads to allocate $ 90,000 ? Item A Item BOverheads are to be allocated / 2 3 / 1 3Stock purchases expected to be $120,000 $150,000 Markup required: 60,000 30,000 120,000 150,000 = 50% = 20%
  6. 6. Working with Mark-UpsBe careful working with percentagesMark-up can be expressed as a percentage onto cost, or alternatively as apercentage of the selling price.(The percentage stated will be different).Example: Price = cost + mark-up $125 = $100 + $25 20% Profit Margin 25% Mark-up on Cost Mark-up: The percentage that the cost price is increased by, to arrive at the selling price. Margin: How much of the selling price is markup for the business.
  7. 7. SummaryUnderstanding the relationship between costs, prices,volume of output, and profit is important.•Desired profit should be treated as a cost to be recovered•If costs (including profit) are known, then: – Estimating volume (hours of work, or units to be sold) allows you to calculate the price to be charged – Estimating price allows you to calculate the volume required to be sold (breakeven)
  8. 8. Find Out