If you run a business, you know that pricing your products is much more difficult than simply slapping a sticker on them. You need to consider how much it cost to produce and how much margin to put on top in order to turn a profit. That’s why cost price is so important.
In this article, we’ll define cost price, reveal how to calculate cost price, and review the formula for cost price, too. Finally, we’ll discuss how solving for cost price can help your business properly price its retail or wholesale inventory.
What is cost price?
Cost price is the amount of money required to create a product that will be sold. In other words, it’s the price it costs to produce a product for sale without any profit added. Calculating cost price is an absolutely essential step in properly pricing inventory for retail or wholesale distribution.
When you determine cost price, you’ll need to consider many data points, including the cost of labor, components and parts, tools, marketing costs, and overhead. Determining an accurate cost price will help you then decide the sale price.
What is the formula for cost price?
The formula for cost price is simple addition. To solve for cost price of all the units of one product you make, simply sum up the cost of:
Labor + Parts/Components + Tools + Marketing + Overhead
Here’s a little bit more information about each of these categories.
Your labor costs can be calculated by considering just how many working hours it takes to produce the product over a given period of time, and how much those working hours cost you.
Parts or Components
Calculate how much cash you spend acquiring the parts and components required to manufacture the product in bulk.
Do you use any equipment, machinery, or special tools to produce a given item? If so, the cost of using and maintaining these assets over the same given period of time should be factored into your cost price formula.
What does your business spend on marketing a given product? These costs must be considered to determine an accurate cost price.
Finally, you’ll need to calculate the indirect costs of producing this product in bulk. This includes insurance, rent, warehouse space, utilities, and storage costs.
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How to calculate cost price of an item
Now, when you add up all the costs outlined above, you’ll probably get a large number. One that far exceeds the cost of a single item your business has produced.
That’s because to truly calculate cost price per item, you need to think about the cost of producing many units of something—then reduce that cost down to a unit price.
Once you have all the data required, use the aforementioned cost price formula to add up the total labor, parts, tools, marketing, and overhead costs. This will include costs like running and servicing machinery, paying rent, advertising, and storage.
Then, you can divide that lump sum into units. If your parts cost is already broken up into a per unit cost, remember to either multiply that number by the total units made in a given period of time, or to simply add it to the per unit cost after dividing the rest of the sum by the units produced.
Here’s an example. Say you make 30,000 lightbulbs a year at the following costs:
Total cost price: $60,000
Total cost price per unit: $60,000 / 30,000 light bulbs = $2 per lightbulb
In this example, we’re adding up all the costs for producing many lightbulbs over the course of a year. Then, we’re dividing that sum by the number of units manufactured to arrive at a cost price per bulb.
How to price items using cost price
Cost price is an essential determinant in setting your retail and wholesale price. There are a few different strategies to consider, including setting a desired profit margin and doubling your cost price.
Strategy 1: Select a profit margin
In this pricing strategy, your company will decide what kind of profit margin to place on a given item.
Here’s an example. Remember that lightbulb with a cost price of $2? Well, say your company has a profit margin goal of at least 30% on all items. So you mark up the lightbulb by 50%. That’ll give you a retail price of $3 per lightbulb. That’s a 33.3% profit margin, just above your goal.
Related: What’s the Difference Between Markup and Margin?
Strategy 2: Double your cost price
Another simple way to price your products is to double your cost price. This means those $2 lightbulbs will be sold at $4, a 100% markup and a 50% profit margin.
Want more pricing strategies? Learn how to calculate your wholesale price.
However you decide to price your inventory, you’ll want to consider your cost price, competitors’ pricing, supply and demand, and landed cost.
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