Fixing the selling price can be based upon a value basis or
a cost plus basis with either basis subject to modification
according to market conditions. Not exactly scientific and
true in all cases but the most profitable businesses tend
to be managed by accountants while the best sales growth
companies have a sales oriented manager at the helm.
Value basis is used to set selling prices according to the
amount the customer will pay for the product and the value
of products or services being provided. A strong influence
when using a value basis are the benefits a customer will
derive from purchasing the product from each business
compared with alternative suppliers and the general market
rate for that type of product.
Using a value basis that prices products above the general
market level requires support and a marketing strategy to
demonstrate to the market place the benefits and advantages
a prospective client receives. Pricing a product or service
below the accepted market price requires to be supported
with ensuring as wide an audience as possible is aware of
the bargain prices and the reasons why a lower price is
being offered.
To establish the most profitable level at which selling
prices should be pitched it is important to conduct market
research to determine the general level of pricing within
the product area. Also list the benefits and advantages
within the context of other competitive products of the
specific products being offered to enable the business to
use these factors in support of the price structure adopted.
To maximum level at which value basis prices can be set is
dependent upon the value the target customer places on that
product or service taking into consideration the quality,
service, availability and benefits provided.
Cost based pricing is a financial accounting calculation
based upon fixing a gross profit margin that the business
requires given the expected sales volume and fixed overhead
or operating costs to produce a net profit. Normally a
sales price set using a cost basis would be the amount paid
for the product plus an incremental percentage.
Cost based pricing usually occurs in areas where
competition is often working on the same cost basis and by
selling similar products and services the volume of sales
is sensitive to competitive prices. Market research should
establish the range of competitive prices.
There are a number of influences that impact on setting the
selling price of a product in addition to the cost and
competition. Sales location, added values, buying policy,
operational costs and others all require factoring into the
calculation. Business size also has an influence as small
business accounting is less sophisticated than accounting
and financial control in larger businesses.
The tow single most important factors in setting the
selling price of a product or service to generate the
highest profit margin attainable are the competition and
the original cost of the product.
In many cases the existing competition has already set a
price for the product. Each business has to decide whether
to accept this price according to the expected volume and
the gross profit margin generated or charge a higher or
lower price with the consequential effect on sales volume.
The purchase price paid drives the competitive edge. Larger
business have greater opportunities to buy in larger
quantities and obtain cheaper prices and many high volume
businesses will search to source products from overseas
markets to obtain even cheaper products.
If the purchase price paid by competitors is low then that
cost must be either matched by adopting similar business
practises or the products sold into a niche area of the
market where more flexible prices can be obtained at the
required volume to generate the gross margin required to
cover fixed operating costs and achieve the target net
profit.
Different prices can be set for different customers to
exploit higher profit margins where possible and achieve
higher volumes in market conditions where the price has a
major influence on quantities bought. A manufacturer will
often set different prices for each customer dependent on
volumes purchased and the negotiation skills of the client
purchasing function.
Market conditions often determine a range of pricing
policies including offering quantity discounts for higher
volumes, cash discounts for faster settlement, lower than
normal prices to allow a market to be penetrated and
established more easily and higher than normal prices in
situations where supply may exceed demand. The accounting
software or bookkeeping system employed should identify
gains and losses due to different pricing structures.
The levels of supply and demand may change over time and a
flexible pricing policy to take advantage of these changes
is desirable. It is an economic fact that when demand
exceeds supply prices will increase and when supply exceeds
demand prices go lower. Failure to react quickly has a
major impact on the total gross margin attained.
The overriding decision to be taken on setting selling
prices is the amount of gross profit generated by the sales
volume of those products in relation to current business
policy and fixed operating costs and profit requirements
that business needs to achieve and demonstrate through the
accounting figures produced by the final bookkeeping
reckoning...
From an accounting point of view the sales volume and price
of each product should be calculated to determine the
previous gross profit margin attained and planned for the
future. The actual or forecast gross profit margins must
cover the fixed operating costs of the business or remedial
action taken to ensure the business is profitable. Setting
prices is a combined decision of the sales and accounting
function.
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Terry Cartwright, accountant at DIY Accounting, designs UK
Accounting Software at http://www.diyaccounting.co.uk/
providing accounting solutions for small to medium sized
business and bookkeeping software at
http://www.diyaccounting.co.uk/bookkeeping.htm
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