What is the correct asking price for my product or service? It is one of the most important questions that a starting entrepreneur must ask. How do you determine the correct price? You find out with a cost price calculation.
The cost price: what is that again?
The cost price consists of the total cost that you have to make or deliver a product or service. If you are going to offer multiple products or services in your company, you will therefore have to see which calculation you want to use for each product or service.
A concrete cost price calculation reduces the risk of underestimating fixed and variable expenses. The correct asking price is, of course higher than your total costs because you want to make a profit. How much you can ask differs per company.
How do you calculate the cost price?
There are various ways to determine the correct cost price. A good starting point is to review your future purchasing policy for a specific period – for example, per month, quarter or year.
For example, if you run a woodworking company, you have to find out how much per type of wood or associated materials you want to purchase and process these findings in your business administration.
Calculate variable costs
Then it is important to calculate the variable costs for each product. This means: the amounts that can be influenced by decreases or increases in the volume of production, such as:
- Purchase price
- Shipping costs
- Transportation costs
- (Any) import costs
Do you work with multiple products or services at the same time? Then it is best to divide the costs proportionally.
Calculate fixed costs
The next step is to calculate the fixed costs, where you must take into account, among other things, costs for you:
- Business premises
- Warehouse / storage space
- Marketing budget
- Car and travel expenses
- (Possible) personnel costs
Calculating your fixed costs may seem easier than it is because you often have to divide these costs over the various products that you offer in your business.
Dividing fixed costs
Below you will find two effective methods to distribute the fixed costs successfully:
- They integrated cost calculation. The integral cost calculation is a good way for starters to gain insight into the fixed costs, because their company is often not that big yet. You then add up all fixed costs and then divide them into overall products or services you offer.
- ABC method. The ABC method (Activity Based Costing in full) is a bit more extensive. In that case, you recalculate the fixed costs for the various departments within the company.
Then you determine per department for what percentage ‘use is made’ of a product or service: you then divide the fixed costs proportionally.
What is the correct costing method?
Once you have figured out what your business costs are, you will determine the cost price per product or service. This step-by-step plan (where we use the quarter as the period) will help you on your way:
- Add up all the variable costs you incur per quarter
- Calculate the fixed costs that you incur for the product over the quarter (this can be done via an integral cost calculation as well as the ABC method)
- Add these costs together, and you are left with the purchase value
- Then calculate how many products you will be purchasing over the quarter
- Divide the purchase value (3) by the number of products / services (4). Now you know what ideally the cost of your product or service should be
Calculate the profit percentage
The cost is the minimum amount you will have to charge to avoid loss. But preferably you also want to make a profit with your company.
Before you can determine a reasonable profit percentage, you must first calculate a certain margin per product or service. When determining this margin, you should at least consider the following points:
- Supply and demand: find out how much demand there is for your products and services. Are you one of the few providers in your region? Then you can put a little more margin on the price
- Or do you move in a niche, and are there few comparable products or services available on the market? Then you enter such a specialized segment that this also justifies a more expensive cost price, but do not overdo it
- Exclusivity: in line with this, you should also look at the exclusivity of your product or service. The more unique the product or service, the higher the margin you can calculate on it
- Quality: cheap is (often) expensive. To a certain extent, customers and clients also realize this. That is why as an entrepreneur, you can charge a higher price for good and sustainable products or services
- Competition: pricing yourself out of the market is something you – especially as a starter – want to avoid as much as possible. Therefore, take a good look at the asking price of competitors and do not deviate too much from this in your own pricing.
Calculating cost price: what are the pitfalls?
An old acquaintance in the field of starter pitfalls is that you estimate the cost price too low in order to outsmart competitors. The chance that people will immediately come to these ‘bargains’ is indeed high.
Such low prices are often unsustainable in the long run. How will your customers react if you increase your prices in one go?
So try to look a little further ahead: it doesn’t have to be a bad idea to choose a competitive pricing strategy. First, let go of a concrete cost estimate so that you will not be faced with unpleasant surprises later on.
You do this by keeping a close eye on the balance between the costs and potential returns to the areas of materials and raw materials, wages, housing, depreciation, interest, and man-hours.
What also happens regularly is that entrepreneurs adhere too much to the industry average without the certainty that they will end up financially well with those rates.
Annual price indexation
Money is worthless every year due to inflation. Supermarkets take advantage of this by raising their prices. This is how the products retain their value.
As a starter, you can also respond to this by adjusting your prices annually for inflation. It is often easier to sell a price increase to a new customer than to a regular customer.