How to Calculate Cost Price Margin

Determining The Right Price for Your Product or Service is Crucial For Business Sucess

Whether selling a good or a service, businesses must decide how much to charge for that good or service. Businesspeople do a specific set of calculations to answer two questions: 1) how much they should charge to cover the direct cost of producing the product and 2) how much they should charge to cover additional costs not directly associated with producing the product. In the end, businesses need to charge enough to cover not only these two types of cost but also to have money left over for savings and investment. Calling the money left over a "cost price margin" is a bit of a misnomer. What the businessperson is trying to measure is how much profit he or she has over their costs--and the more, the better.

Things You'll Need

• Standard handheld or desktop calculator

Instructions

Calculating Costs & Revenue

1. Calculate direct cost. Typically, this will be the cost of the materials and labor used to produce the product. The formula is DC = CM + CL, where DC is the direct costs, CM is the cost of the materials, and CL is the cost of the labor. For example:

   let CM = $6000
   let CL = $5000

   then the direct cost is DC = CM + CL = $6000 + $5000 = $11,000.

2. Calculate indirect cost. Typically, these are costs not directly related to the cost of producing a product. These are things that a business must spend money on whether or not they make a product or sell it. Businesses calculate this type of cost over a given time period, e.g., a day, a month or a year. For example, most businesses must pay rent or taxes and they must pay for utilities and insurance.

3. Calculate total costs for a given time period. The general formula is N * DC + IC, where N is the number of products the business produced over a given time period, DC is the direct cost, and IC is the indirect cost. For example:

   let N = 100 (i.e., 100 products produced in one month),
   let DC = $11,000 for one product
   let IC = $10,000 for one month

   then the total cost is N * DC + IC = 100 * $11,000 + $10,000 = $1,100,000.

4. Calculate the profit over a given time period. The formula for profit is N * (SP -- DC) -- IC, where N is the number of products the business produced over a given time period, SP is the selling price for one product , DC is the direct cost and IC is the indirect cost. For example,

   let N = 100 (i.e., 100 products produced in one month),
   let SP = $14,000
   let DC = $11,000
   let IC = $10,000

   then the profit for one month is N * (SP -- DC) + IC = 100 * ($14,000 -- $11,000) - $10,000 = $290,000.

5. Calculate cost or price margin. The formula is P/(N * SP), where P is the profit over a given time period (see step 4), N is the number of products the business produced over a given time period and SP is the selling price for one product. For example:

   let N = 100, the total number of products produced in one month
   let SP = $14,000
   let P = $290,000

   then the cost or price margin (for one month) is

   P /(N *SP) = $290,000/(100 * $14,000) = $290,000/$1,400,000 = 0.207, or about 21 percent.

   The larger the cost or price margin, the more profitable the business, and the more profitable the business, the more it can invest in itself or the more likely it can survive a recession.

Tips & Warnings

• While all the above calculations can easily be done by hand, unless your business is quite simple, you'll want to at least invest in some good accounting software or hire a qualified accountant.

References

• decide how much to charge for that good or service

Resources

• Useful Online Financial Calculators