What is the cost price and how to calculate it?

What is the cost price and how to calculate it?

Production costs are part of the economic data that every company must know and take into account. This indicator allows them to effectively manage their activities, whether it concerns the production of goods, trade or the provision of services.

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What is the cost price?

The cost price, or cost price, corresponds to the sum of the costs incurred by a company to produce and distribute a particular good or service. He must therefore take into account all the expenses incurred for this product. It consists of the following elements:

  • the cost of supply;
  • production cost;
  • distribution cost;
  • administrative costs.

the supply costor purchase cost, includes the charges spent on the purchase of raw materials, goods, finished products and consumable supplies as well as their delivery costs.

the production cost includes all costs related to the design of goods and services. The purchase cost is added here to the other charges related to the manufacture of the product, namely:

  • salaries of personnel involved in production;
  • the cost of the share of depreciation attributable to production;
  • other fixed and variable production costs (electricity consumption and equipment maintenance, workshop rents, etc.).

the delivery cost means the sums borne for the distribution and sale of a product: advertising, packaging, delivery, marketing actions, store rents, salaries of sales, marketing and after-sales teams, as well as related fixed and variable charges commercial activities (electricity consumption, insurance, etc.).

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The administrative costs correspond to the costs of support and administrative functions. Although these expenses do not enter directly into the production of a good or service, they are essential for the proper functioning of businesses. Administrative costs include:

  • the salaries of the administrative teams: general management, human resources, accounting, IT services, etc. ;
  • rents for corporate headquarters and administrative offices;
  • the share of depreciation of equipment used by the support and administrative functions;
  • other fixed and variable charges related to administrative activities (insurance, electricity consumption, etc.).

How to calculate the cost price of a product?

To determine the cost price of a product, it is necessary to distinguish the different categories of expenses that compose it: direct charges and indirect charges.

Direct expenses are expenses that contribute to the manufacture of a good or the performance of a service. They are therefore directly attributable to a particular product or activity.

Indirect charges are not applicable to the process of manufacturing a good or providing a service, therefore to production. However, they are necessary for the operation of the company. Indirect costs relate to general costs (rent, maintenance, electricity, telephone and Internet subscriptions, insurance, postage, etc.), administrative costs, costs related to tools and machines as well as distribution costs such as advertising costs. .

Formula for calculating the cost price

The calculation consists of adding up all the costs necessary for the production and distribution of goods or the provision of services, then dividing them by the quantity of goods or services sold. The formula used to obtain the cost price breaks down as follows:

  • Cost price = sum of direct and indirect costs (production costs, including supply costs + general costs + administrative costs + distribution cost) / number of products sold
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But be careful: to determine the cost price, you must take care to account for all the costs associated with each product or service. The difficulty also lies in the exact allocation of all the indirect costs between the different products or services of the company. This procedure for allocating indirect costs allows costs to be allocated between different goods or services. In order for these indirect costs to be correctly attributed to a specific good or service, several methods can be used to analyze them and assign the most relevant distribution keys. These methods include, for example, the ABC method or the full cost method.

How to interpret the cost price?

First of all, the main interest of calculating the cost price is to allow the selling price of a product or service to be fixed so that companies can amortize their various costs. Indeed, this cost must cover all the expenses incurred for the production and distribution of a good or the provision of a service. Calculating and knowing the selling price is particularly relevant when setting up a business or in commercial negotiations, but it is also necessary throughout the life of a business. When creating a business, the selling price from which the product or service becomes remunerative must be determined to know the profitability of the business.

Knowing your selling price is just as essential during commercial negotiations, because it allows you to discuss it, but also to adjust it according to the commercial opportunities that appear and thus establish a sufficient margin.

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This is not the only interest of this operation, because the calculation of the selling price must make it possible to determine a gross margin in order to evaluate the profitability of an activity. It is thanks to this indicator that companies will know if they can make a profit on the sale of their goods or services.

To set the selling price, all these elements must be integrated by adding the net profit objectives to be achieved. The selling price of a good or service to be marketed is therefore obtained by adding the cost price to the desired commercial margin, without forgetting to include VAT.

  • Selling price = cost price + commercial margin + VAT

Obtaining the selling price also helps to define the overall turnover of the product or service. To calculate overall sales, simply multiply the selling price of the product or service by the quantity sold.

Knowing your cost price therefore helps in calculating the selling price, but it also allows companies to make certain decisions regarding the management of their various activities:

  • reduce or even eliminate certain expenses to improve the cost price;
  • concentrate their activity on certain products or services, and in particular those which offer the largest margin;
  • diversify their activity in order to offer more profitable goods or services;
  • increase the selling price of products or services to improve gross margin;
  • look for suppliers offering more attractive prices to reduce costs.

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