Costing & Pricing

In: Business and Management

Submitted By kingklass
Words 2587
Pages 11

The key principle of costing is to calculate the true cost of a product or service while pricing is determined by demand, market conditions and factors which influence pricing such as advertising, promotional activity and the ability to differentiate from competitive or alternative products and services.

Costing is based on the simple principle of recovering cost.

Cost are classified as Variable or Fixed.

Variable costs are those costs which vary in direct proportion to output. For every unit of output there is a clear unit of input - usually material and labour.

Fixed costs are those that exist regardless of the level of output or activity. These will include rent and rates, insurance etc.

In reality many costs are semi fixed or semi variable. In other words there is a degree of variability with output but a significant proportion of the cost is fixed. Power, telephone, transport (for an in house fleet) are examples.

The critical issue is how to allocate the fixed costs to each unit of output. Underpinning this decision is the ability to predict the level of output which will be achieved in the future. In other words how much are we going to sell? This creates the interface with the pricing policy and the need to understand the price elasticity of demand (more later).

For costing to be effective there must be a clear and unambiguous understanding of the cost structure of the business and what is actually happening in the business, ie, levels of productivity, material yield, breakdowns etc.

The crucial is to decide how to allocate the fixed costs (or overheads) against each unit of output/sales in order to recover 100% of the fixed cost over a period of time and make an acceptable profit.

If a business has a single product or service, each unit of which consumes exactly the same amount of variable cost, then…...

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