Cost plus Pricing Formula

Cost plus Pricing Formula

In cost plus pricing method a standard percentage of profit margins are added to the cost of the product or project. There are two methods of adding cost i.e. % profit of sales or % Profit margin on cost.

Cost Plus pricing = Cost + Profit Margin on cost

Cost Plus Pricing = Cost + profit Margin on selling Price

Example (Cost Profit Margin)

Cost = 120,000

Profit Margin on cost = 25%

Calculate the selling Price

Solution

= 120,000 x .25

= 30,000

Cost Plus pricing = Cost + Profit Margin on cost

= 120,000 + 30,000

= 150,000

Example (Selling Price Profit Margin)

Cost = 120,000

Profit Margin on Selling Price = 25%

Calculate the selling Price

Solution

Cost Plus pricing = Cost + Profit Margin on cost

= 120,000 / (1-Profit Margin)

= 120,000/.75

= 160,000

Disadvantages of Full Cost Plus Pricing

Disadvantages of Full Cost plus Pricing

1.    Competitor is ignored

In full cost plus pricing system competitor prices are ignored, which is a key factor for determining the price. Ignoring competition can bring huge losses to the organization.

2.    Market conditions are ignored

Full cost plus pricing system does not take into account the market condition i.e. demand & supply of the product, which again a key consideration for price determination.

3.    Profit Margin Decision

Management takes the profit margin decision, which could be very biased decision. There is no mechanism for profit margin. Biased decision making in this regard can bring heavy damage to the product.

4.    Full cost is difficult task

In many cases there is not possible to calculate the full cost of the product i.e. very small products, or different variety of product is being produced under same roof.

5.    No incentive for Cost Control

Profit is guaranteed in this method, therefore there is no incentive to control the cost.

6.    More Wastage is Expected

Due to guaranteed profit, there is no incentive to control wastage in the production process.

Advantages of Full Cost Plus Pricing

Advantages of Full cost plus pricing

1.    All cost are covered

Under full cost pricing all cost are covered and therefore there is no loss condition.

2.    Profit is known

In full cost pricing the profit is known from the project. Therefore there is no uncertainty about the profitability; therefore organization can focus on project.

3.    Quality Good

In full cost pricing there is more focus on quality, because cost is to be charged to customer in full cost pricing method.