Cost based pricing can be done using 02 methods:
Difference between these 02 methods can be illustrated as follows
Mark Up Method
This is where the company decides to add a percentage of cost as the profit to arrive at the selling price of a product. Mark up can be based on total cost/prime cost/ overheads/production cost or any other cost arises in the organization. Concept is that it should use a % of a certain cost to arrive at the profit figure. Based on above concept the formula for mark up method can be stated as follows:
Total/Prime Cost+ Profit Mark Up = Selling Price
100% + X% = (100+X)%
Example :
Firm wishes to achieve a 20% of a profit mark up on its total cost and total cost of product A is calculated as $ 100. Calculate the profit figure and the selling price.
Total Cost+ Profit Mark Up = Selling Price
100% + X% = (100+X)%
100% + 20% = 120%
Therefore when Total cost is $ 100:
Total Cost+ Profit Mark Up = Selling Price
$ 100 + $ 20 = $ 120
Margin Method
This is where the firm decides a certain percentage on selling price has to be the profit amount. Calculation starts from the selling price and they decide on the percentage of profit and then decide what has to be the cost figure.If the cost figure is given working backwards has to be done to identify the profit figure and the selling price. Based on this concept the the profit figure based on profit margin method can be calculated using the formula stated below:
Total Cost + Profit Margin = Selling Price
Selling price = 100%
Profit Margin = X%
Total cost = 100% – X%
Therefore:
Total Cost+ Profit Mark Up = Selling Price
(100%-X%) + X% = 100%
Example:
Firm wishes to achieve 20% of profit margin on its sales price when its total cost of production is $ 100. Calculate the profit figure and the selling price.
Total Cost+ Profit Mark Up = Selling Price
(100%-X%) + X% = 100%
(100%-20%) + 20% = 100%
80% + 20% = 100%
If 80% = $ 100
20% = $ 100/80*20 = $ 25
Therefore the selling price has to be:
$ 100 + $ 25 = $ 125
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Nice post in addition to the example, to illustrate more on the example can use a trading account to give more understanding to the reader
thank you