Pricing products

Cost Behaviour

1. 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, interest.

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.

Expected wages (if any)10,000

Estimated overheads for year14,000

Desired profit for owner36,000

Example:Cost of materials to be sold (or stock purchases)

$150,000

60,000

150,000Markup required: = 40%

Total of other costs and overhead to recover… $ 60,000

Exercise

Expected wages (if any)25,000

Estimated overheads for year10,000

Desired profit for owner40,000

Calculate the required markup percentage:

Cost of materials to be sold (or stock purchases)$125,000

75,000

125,000Markup required: = 60%

Total of other costs and overhead to recover… $ 75,000

Expected wages for staff 30,000Estimated expenses for year 10,000Desired profit for owner 50,000

Total overheads to allocate

Overheads are to be allocated

Stock purchases expected to be

Another exerciseCalculate the required markup percentage for each product:

Markup required: 60,000120,000

= 50%

30,000150,000

= 20%

$ 90,000?

Item A Item B

2/3 1/3

$120,000 $150,000

Working with Mark-Ups

Be careful working with percentagesMark-up can be expressed as a percentage onto cost, or alternatively as a

percentage of the selling price.(The percentage stated will be different).

Example:

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.

Price = cost + mark-up$125 = $100 + $25

Summary

Understanding 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)