The importance of costing
Cost accounting records all the costing accounts and estimates the cost of products. Enterprise uses cost accounting to determine expenses, estimate the cost of products and price them. If costing and pricing are not proficient, it will be difficult for a business to plan, make a profit and survive. Thus, cost accounting is a valuable tool for managing the financial performance of a business.
Estimating the cost of products
The result of any cost accounting system is to calculate the cost of products and services. The cost of any product comprises both variable and fixed costs. Variable costs differ from fixed costs in their correlation with the level of production, as variable costs change with the level of production, but the fixed costs relatively didn’t. In estimating the cost of products, there should be no issue in calculating the variable costs per product, but it is more complicated to estimate the fixed cost per products produced. Thus, firms usually choose a particular method to distribute the overheads on a given quantity produced during a certain period to calculate the overhead cost per individual product. However, allocating overheads on manufactured products is not a straightforward method and requires some assumptions and criteria to distribute the overheads over the quantity produced. Such criteria of overheads distribution range from a simple average, direct labour cost percentage or production time-hours percentage.
How to price a product?
A business considers many factors before pricing its products. Consideration factors are the cost, market factors, business objectives and profitability. There are many pricing methods including the variable cost-plus, historical, average cost and competitive pricing. In variable cost-plus pricing, the selling price is calculated by adding a mark-up margin, e.g. 25%, to the variable cost per product. For example, the variable cost for product A is £10, and the mark-up is 25%, therefore the price is £12.50. Historical pricing exists when a selling price is tied to the last used price, and it is applied when the cost of a product does not update in real-time. For example, Product A is being sold for £10 and will continue at the same price for the coming period. The average cost pricing involves adding a markup to the estimated total cost of a product. For example, the average production cost is £10, and the selling price is £13 per product. In competitive pricing, it is pricing a product or service based on relative market competition. This pricing method is used more often by businesses selling similar products and services. For example, the competitive market price of a mobile phone is £250, therefore a company may sell its mobile brand for £249.
This article is extracted from my new book- Mastering Enterprise Skills for Potential Entrepreneurs, which will be published soon. If you want to receive more information about the book, you please register using this link.
Munther Al Dawood
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