Cost Based Pricing

Cost Based Pricing

ZIMSEC O Level Business Studies Notes: Marketing: Cost Based Pricing

  • Refers to a variety of pricing strategies which involve the addition of a profit element on top of the costs of production
  • The aim is to make sure that costs incurred in production of each unit are covered by the selling price of that unit
  • Popular cost based pricing models include:
  • Cost Plus Pricing
  • Target Pricing and
  • Marginal Pricing

Cost Plus Pricing

  • pricing method in which a fixed sum or a percentage of the total cost is added (as income or profit) to the cost of the product to arrive at its selling price
  • First the business determines the total costs of production
  • This includes determining both the fixed and variable costs of production
  • These total costs are then allocated to each unit of production to get the total cost per unit
  • A mark up is then added to these cost per unit to arrive at the selling price per unit
  • In a business that does not produce the items it sells e.g retailers the cost of goods sold is used instead of the total costs.
  • The cost of goods sold includes the purchase price and other expenses incurred in bringing the products into a salable condition e.g. carriage inwards, import duty, freight charges etc
  • The selling price is given using the formula
  • \text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Total Cost Per Unit}

Target Pricing

  • This is also known as break even pricing
  • Here the business first determines a planned level of output/sales volume
  • It also determines an acceptable level of profit
  • Fixed costs in that particular period are also determined
  • A break even price is then calculated i.e. a price level at which the business will make neither loss nor profit
  • The total overheads are then calculated and the selling price determined using the formula:
  • \text{Profit}= \dfrac{\text{Total Costs}}{\text{Planned Level of Production}}
  • \text{Selling Price}= \text{Profit+ Break Even Price}
  • The emphasis here is on a total amount of profit in a given period rather than on profit per unit as in cost plus pricing

Marginal Pricing

  • Marginal cost is the cost of producing one extra unit of production
  • In principle it refers to all the variable costs incurred in producing each extra unit of production
  • Marginal cost pricing ignores fixed costs when setting the price
  • The marginal cost per each unit is first determined an a satisfactory mark up is added to this marginal cost to get the selling price
  • This mark up acts as contribution which contributes towards covering fixed costs and eventually profit
  • The formula for finding the selling price when using marginal costing is:
  • \text{Selling Price}= ( 1+\text{ mark up percentage } )*\text{Variable Cost Per Unit}

NB To read about the advantages and disadvantages of cost based pricing click here

To access more topics go to theĀ O Level Business Notes

About the Author:

He holds an Honours in Accountancy degree from the University of Zimbabwe. He is passionate about technology and its practical application in today's world.
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