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)$150,000 60, ,000 Markup required: = 40% Total of other costs and overhead to recover…$ 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)$125,000 75, ,000 Markup required: = 60% Total of other costs and overhead to recover…$ 75,000

Expected wages for staff30,000 Estimated expenses for year10,000 Desired profit for owner50,000 Total overheads to allocate Overheads are to be allocated Stock purchases expected to be Another exercise Calculate the required markup percentage for each product: Markup required: 60, ,000 = 50% 30, ,000 = 20% $ 90,000 ? Item A Item B 2/32/3 1/31/3 $120,000 $150,000

Working with Mark-Ups Be careful working with percentages Mark-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)