In today’s competitive market, proficient costing and pricing are vital for any business to survive and sustain. Yet, costing is not easy to perform, and thus, it requires certain preparations to ensure proper recording and accurate estimation of product costs. For these reasons, firms set up systems, assumptions and record transactions to reach cost estimates. These cost estimates will be helpful for any firm to price products and plan profitability. In this article, I address the importance of cost accounting for businesses and explain methods of pricing.
The importance of costing
Any cost accounting aims at recording expenses and estimating the product cost, and firms typically manage cost accounting to price products and ensure profitability. If costing and pricing are not proficient, it will be difficult for a business to plan, make a profit and survive. For these reasons, cost accounting is a valuable tool to manage the whole financial performance of any business.
Estimating product costs
The ultimate objective of any costing system is to accurately estimate product costs and provide the basis for the management to decide on selling prices. This approach helps companies to plan and reach profitability and control cash flows. Yet, it is not easy for any business to estimate product costs without preparing the ground for it. These difficulties result from the fact that the cost of any product comprises 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 don’t. This problematic issue forces any company to create a costing system and make assumptions to estimate product costs. To estimate a product cost, a firm creates a costing system, identifies products and cost accounts and records expenses to product centres. Cost recording is straightforward for the direct or variable expenses, but it is a bit difficult to absorb overheads for units produced unless it is handled with assumptions and criterion. The costing system creates a cost centre with a percentage of overhead absorption, and this will work automatically to allocate direct and overhead expenses to every product. Such a criterion of overheads distribution ranges from a simple average, direct labour cost percentage or production time-hours percentage. The ultimate output of this cost-accounting system is cost estimates of products, enabling any management to profitability price products.
How to price a product?
A firm considers some business factors before pricing its products. These factors include product costs, market forces, business objectives and profitability. In practice, there are many pricing methods including, the variable cost-plus, historical pricing, average cost and competitive pricing. In variable cost-plus pricing, the selling price is calculated by adding a mark-up, e.g. 25%, to the product variable cost. For example, the variable cost for product A is £10, and the mark-up is 25%, then the price is £12.50. Historical pricing exists when a selling price is relevant to the past used prices, and it is best applied when the product cost does not change over time. For example, Product A is sold for £10 and will continue at the same price in future. The average-cost pricing involves adding a markup, e.g. 15%, to the total product cost. For example, the average product cost is £10, and the selling price is £12 per product. In competitive pricing, firms price a product relevant to the market competition. This pricing method is best applicable for firms, that sell similar products and services. For example, when the competitive price of a mobile phone is £250, a company decides to sell its mobile brand for £249.
This article is extracted from my new book- Mastering Enterprise Skills for Potential Entrepreneurs, which can be found on www.amazon.co.uk. If you want to receive more information about the book and our activities, you can register in our newsletter by using this link.
Munther Al Dawood
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