One of the biggest challenges companies face when launching new or revamped products is determining the right price to charge for these items. Choosing the wrong price can cause you to lose money.
Aim too high and people will find cheaper options or abstain from making a purchase at all.
Set the price too low and you cut your profit margins to nil or risk selling at a loss.
Fortunately, setting the perfect price for your products and services doesn’t have to be complicated and you won’t have to rely on guesswork. Today, we’ll show you how to calculate the best selling price using the cost price formula.
What is Cost Price?
Before we get to the math, let’s first define what cost price is.
As you may have guessed from the terminology, cost price is simply the amount of money it costs you to make each product or provide a service. What is the difference between cost and price? Cost is the amount of money you spent to make the product or service. Price is what you will charge for it.
As such, cost price includes all the money spent on creating a product or service, including:
- Research Costs
- Property Costs
- Production Costs
- Worker Wages
- Any Other Expenses Associated with Production
With such a wide range of variables to consider, coming up with a price for your product or service should be given a great deal of thought and consideration. If you fail to factor in all of the relevant expenses into your calculation, you may actually set your price too low.
Don’t fret, though. One way to ensure this doesn’t happen is by including contingency sums in your calculation. This way, if you miss a cost or make a miscalculation, your cost price analysis can still be viable.
Once you know the cost price of a product and your profit margin, you can then tabulate your wholesale price. From there, we can set a Manufacturer’s Suggested Retail Price (MSRP) based on the wholesale price and the amount of profit we want to make. Just remember, the MSRP will also need to include a profit margin for your partners/distributors.
And now that we know the cost price meaning, let’s discuss how it can help your business.
When Do I Need to Know Cost Price?
One of the questions we’re asked often is, “When do I need to know cost price?”
The simple answer is, “always.”
However, in more practical terms, you should understand the cost price of creating your products and services when you’re launching them and setting your initial price point.
After that, it’s advisable to return and review them any time there’s a change in the cost of production. Do your materials cost more than they did six months ago? You should run a new cost price calculation. Has the cost of your manufacturing changed? Time to recalculate.
The reason for this, as mentioned earlier, is because cost pricing calculations ensure you have a way of arriving at a price point that isn’t going to cost you money in lost sales or through terrible profit margins.
And with so many variables in the cost price equation, any change in your production costs can have a dramatic effect on your actual pricing.
So, the good rule of thumb here is you should be checking your cost price for products regularly. You should absolutely be checking it when production prices change.
What is the Cost Price Formula?
Now that we’ve clarified why cost pricing matters and when you should be using it, it’s time to discuss what the cost price formula is.
The cost price formula is nothing more than the calculation you’ll use to determine what it costs to make a product or provide a service.
We’ll need a number of different variables to complete this calculation. Common variables include labor costs, component costs, marketing costs, overhead, and so on.
Once you’re armed with these figures, it’s time for some simple math:
Cost price = labor + overhead + materials + tools + marketing costs
This is the basic version of the equation. You can add additional costs to the formula if you have them, or remove ones you don’t. You might also want to add in some contingency amount if you’re worried you might have missed or undervalued the cost of something, just to give yourself some wiggle room.
And really, that’s it. Adding those numbers together will give you a cost price.
Now let’s look at it in action.
Cost Price Formula Example
Now that we know the formula, let’s put it to work with some examples so you can see how you’d use it in the real world. There are online calculators where you can simply plug in numbers, but honestly, it’s good to know how to do this the old fashioned way too.
1. Gather Data on All Costs
The first step in the process is to simply gather all the cost data you can for your product or service. The more data you have, the more accurate your cost price will be.
This basically means considering all the costs we’ve talked about in previous sections. If there are other charges like freight or carrying costs or things of that nature, you should include those as well.
2. Calculate Your Cost Price Per Unit
In this step, you’ll basically take all of that data and do the math.
Let’s assume you make 1,000 units of a product per year. The materials cost you $5.00 per product. Annual maintenance on the machinery used to make your product is $2,000. You spend $6,000 per on marketing, $10,000 on your rent, and $4,000 on other business costs related to production.
The equation would look like this:
Cost price = $2,000 + $6,000 + $10,000 + $4,000/1000 + $5.00
When you do the math, that works out to $27.00 per unit.
3. Determine Your Profit Margin
Here you’ll need to figure out what your acceptable profit margin is. Determining that is a whole different article, but basically you’ll want to look at your costs, what your competitors are charging, and various other factors.
4. Work Backwards Using Your Cost Price
With all of this information, now it’s just a matter of using your cost price to work backwards to determine how many units you need to sell per year to cover your expenses and other costs.
Pricing is a topic that keeps many business owners up at night. Getting the pricing of your products or services wrong is a recipe for financial disaster, so it’s imperative to get this number right.
The cost price formula we’ve shared in this article will take the guesswork out of pricing your offerings, ensuring you settle on an MSRP that will appeal to customers while also providing a healthy profit margin that will cover your expenses and allow you to make money. Give it a try and see for yourself!
Additionally, if you’re looking to streamline your inventory management and further optimize your pricing strategy, consider checking out Linnworks. Our comprehensive commerce ops solution can be a game-changer for businesses aiming for efficiency and profitability.