Many businesses use cost based pricing, or cost plus pricing but what is it?  How does it work, what are its advantages and disadvantages

When it comes to pricing your goods or services, there are a few popular strategies that business owners use.  The most well-known is cost-based pricing, where you charge what it costs you to produce or provide the good or service.

In this weeks I Hate Numbers podcast I'll focus on cost plus pricing is and how it works.  Furthermore , I will look at the pros and cons of using this strategy for your business.

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Do you need to price your products or services for sale but don't know where to start? Have no fear, our free online pricing calculator is here! With just a few pieces of information, our calculator will help you come up with a fair price for your items. So why not give it a try today? You may be surprised at how easy it is!

Conclusion and good to know

Do you need to price your products or services for sale but don't know where to start? Have no fear, our free online pricing calculator is here! With just a few pieces of information, our calculator will help you come up with a fair price for your items. See what mark up and profits are.  So why not give it a try today? You may be surprised at how easy it is!

Join my financial planning and story telling community at Numbers Know How If you want 1-2-1 support then I would be happy to help you create a sound financial plan for your company.

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I Hate Numbers is an easy, humorous but serious read about running a business.  It also shows you how to have a financially rewarding relationship with your numbers. Furthermore, my book will help with that battle between the ears, that all business owners experience. If you feel like you could use some help in this area, buy my book and let me show you how to get on track for success. Not only will you be able to understand your finances better, but you’ll also learn how to take the stress out of money management. Thanks for reading!

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Cost plus pricing is one of the oldest and most reliable methods of pricing that manufacturers and retailers have used. And my reliable, reliable doesn't necessarily mean it's the best one, but it's the one that most manufacturers and most retailers can identify. You take the cost of your product, add something to that product, what we call a markup, and thereby you arrive at the selling price.

If you happen to be VAT registered or registered for sales taxes, add on the relevant amount to cover that sales tax off VAT, and that becomes the price to your customer. Now, in this week's podcast, I'm gonna be looking in more detail what cost plus pricing is, how we go about applying a markup and how we calculate that markup percentage and the merits as well as the weaknesses of

cost plus pricing. You are listening to the I Hate Numbers Podcast with Mahmood Reza. The I Hate Numbers Podcast mission is to help your business survive and thrive by you better understanding and connecting with your numbers. Number love and care is what it's about. Tune in every week. Now here's your host, Mahmood Reza.

Hi folks. My name is Mahmood. I'm an accountant and business finance coach, and I've been running my businesses, I Hate Numbers for over 27 years, and in those 27 years, I've helped thousands of business owners not only make more profit in their businesses, not only increase their financial awareness, but also to win those battles that goes on between their ears, which we all have experience of, to save time,

to save tax and have the businesses that are an aspiration for all of us. Let's crack on with the podcast. Now, cost plus pricing, the first thing we need to focus on is what we mean by cost. Now, if your company was a manufacturer and making, let's say dresses, then the cost of each dress that you manufacture will be made up of the direct material costs, the direct labor, and the variable overhead.

Let's assume that's $10. And then also we have to work out what is the overhead cost for each unit as well. And that overhead, by the way, will be typically things like the rent on the factory area, the depreciation of the machinery, any supervisory cost, there might be any quality inspection. And let's assume that the cost for that is also $10.

So together, the full cost of the manufacturer of each dress is $20. A similar process would apply to a retailer. The stock they buy in, the price they pay for that item of stock is their full cost. Now the next thing we do, having got that basis of cost, we then add something to that, hence the phrase cost plus.

And what this requires us to do is to identify a markup. Now to identify a markup, and if you're thinking like, gosh, there's more mass, more number crunching to be done, fair, not, there'll be a link in the show notes here to a product pricing calculator free to use, where you can just type in your numbers, add in a desired markup and it'll work out the selling prices for you.

So the calculator is really powerful and I'd recommend you check it out. So remember, check out the show notes. The link will be in there. So let's look at how we calculate fixed markups. Now to figure out the markup for cost plus pricing, we look at the total profit that we require, that we desire, and we divide it by the volume, the number of items being produced.

So let's say in our fictional example, we want to earn a hundred thousand dollars on making a hundred electrical cars. Let's call these electrical cars, electric. That's really quite an original name. So what we've got, we look at the level of profit that we wish to earn, which is a hundred thousand. We look at the number of items that we are producing, and in this example, it was a hundred.

Therefore, the markup is a thousand dollars per item. So each product that we make, we add a thousand dollars to the cost to give us the sales price. And that's as simple as that. Take the cost of the item and the desired profit figure that we wish, and those two figures together become the selling price. Now, as a footnote, if you are registered for sales taxes and your clients, your customers are consumers, they will also have to pay the V A T.

So typically we're gonna add the V A T and make that a VAT inclusive price. If your customers are not VAT registered, or more importantly if they are businesses and you are VAT registered, then you can quote the selling price without the VAT being included. Alternatively, you might wish to set a cost plus percentage. Quite common that companies, instead of adding a dollar figure, a sterling figure or a currency figure to the cost will add a percentage to it as well.

Now, in the same principle, we figure out the percentage we'd like to apply, and the good thing is by the way, we may have categories of products and we can apply different percentages to each one. I've seen many businesses apply a uniform percentage across the board and bear with me as we explain why that may be a hinderance

to maximizing the profit that you make in your business. So let's assume our desired profit percentage, our markup percentage is a cool 20%. Now, in our fixed products that we're making, our electrical vehicle, let's assume our desired markup is 20%. So if the product costs, let's say, $5,000, we take 20% of that, that gives us a thousand, and that's a thousand dollars

we add to it as well. If you want it as a calculation, and remember, you've got the online tool that's there for your disposal. You go 5,000 times 1.2, and that gives you $6,000. That's the price. Now a question to consider here is what's that markup for? Well, that markup is not only making a profit over the cost of manufacturing or the cost of buying in that goes towards covering all the additional resources, all the additional overheads we have in our business.

So we will have cost of delivery, we'll have an IT function, perhaps, we'll have the cost of our other staff members, our sales team, our accounts team. Let's not forget the accounts team. You'll have advertising, marketing. You are required to draw a salary and some reward out the company for yourself. So that markup has to cover all of those elements.

Now, you may see some flaws already in this approach here, and I'm going to reinforce those in a few moments. So we talked about what cost plus pricing is. We talked about deciding which cost that we adopt. We've talked about fixed markups, expressed in currency, in dollars, in sterling, we've talked about percentages being used

instead, either of them have their merits. Now let's consider the problems. The problems are of cost plus pricing is, there is no incentive to challenge the cost. You take the cost of what you're doing, you may have costs that are built up from the previous year. You just add a a certain percentage to it, and what you may find is that you become uncompetitive.

Customers don't really care what things cost you to make or to provide. They're interested in does it have utility, does it solve a problem, and is it value for money? The danger in adding percentages, cost plus pricing is that you could become uneconomic. You could become uncompetitive, and also there is no incentive to challenge

and to re-look at your cost base, I'm a big fan of challenging costs. Not to a jewel necessarily, but actually saying, these are my costs. Can I be more efficient? Are there opportunities to reduce non-value added items from there? And we always should be cost conscious, not slashing and burning, but making sure that where we can, we've got productivity being built in,

we've got efficiency and we're reflecting and challenging those costs as much as possible. Another problem with cost plus pricing is, is the identification of the required level of overhead in each our product. A topic for another podcast here can sometimes make it a challenge. Having said that, it is still a very popular method used by thousands of businesses, not just in the UK, but all over the world.

Its merits are it's straightforward and easy. And in the world of business, things that are easy, things that are straightforward to apply, always have a rounding sound of success with business owners and those people in their teams. It's straightforward. The calculations are relatively okay, and most people can identify with a concept of a markup.

Now, folks, before we wrap this show up, just please note that markup and margin are two completely different concepts. Markup is where we take the profit and we link it to the cost. Margin, and please check out the show notes for previous podcast episodes on this, is relating that profit to the selling price of your item.

Folks, I hope you've got some value from this podcast. I'd love it to get your feedback, your comments. Obviously I'd love it if you subscribe, if you feel there's somebody out there who could benefit from listening to this podcast. I love it if you could share it with them. And until next week, folks, get your head down, have a look at your pricing, and look at your costs and look at what your pricing structure would be, applying cost plus pricing.

And don't forget our online calculator tool. Till next week, folks, be sanguine. We hope you enjoyed this episode and appreciate you taking the time to listen to the show. We hope you got some value. If you did, then we'd love it if you shared the episode. We look forward to you joining us next week for another I Hate Numbers episode.