Published on February 5, 2014
Fixation of Selling Price - Cost Analysis and Decision Making:
Fixation of selling price is one of the significant tasks of management. Prices are usually ascertained by market conditions and other economic aspects. Cost volume profit analysis supports the management in fixing the selling prices under diverse conditions.
Pricing under Regular Circumstances Under regular conditions, the prices are based upon aggregate cost of sales so as to cover both permanent as well as variable cost and in totaling to offer for specific required margin of profit. However, prices can be predetermined on the basis of marginal cost by totaling an adequately high margin to marginal cost so as to wrap the predetermined cost and profits. Nevertheless, under other situations, articles may have to be sold at a price below the aggregate cost. In such conditions, the prices must be predetermined on the basis of marginal cost in such an approach so as to coat the marginal cost and put in something in the direction of fixed expenses.
Selling Price lower than the Marginal Cost : From time to time it may become significant to decrease the selling prices to the height of marginal cost or even lower than the marginal cost. In the subsequent conditions the selling price may be fixed even lower than the marginal cost. 1. To bring in a new manufactured goods in the market 2. To widen foreign markets 3. To eradicate the contestant from the market 4. To evade the reduction of expenditure of workforce
5. To ward-off perishable articles 6. To evade additional losses by shutting down the business 7. To ward off in-excess inventories 8. To utilize inactive capacity Let us discuss an illustration to understand this concept better.
Illustration The marginal cost of an article is $ 7.50 and fixed expenses values to $ 112,500. Selling price per unit is $ 8.50 and 20,000 units can be sold at this rate. Decide whether the company must sell the article or not.
Solution Total marginal cost = 20,000 units @ $ 7.50 per unit = $ 150,000 Fixed Cost = $ 112,500 Total Cost = $ 262,500 Total Cost Per Unit = $ 262,500 / 20,000 units = $ 13.125
Although the selling price of $ 8.50 is less than the aggregate cost, yet it is meritorious to sell the article at the selling price of $ 8.50 which is higher than the marginal cost of $ 7.50. This will decrease the loss due to fixed expenses (in case the article is terminated) by $ 20,000 as presented below. Sales = $ 20,000 units @ $ 8.50 per unit = $ 170,000 Loss = Total Cost – Sales = $ 262,500 - $ 170,000 = $ 92,500 Loss if the article is terminated (i.e. fixed expenses) = $ 112,500 Therefore, loss of $20,000 (i.e. $ 112,500 - $ 92,500) will be decreased if article is sold at $ 8.50 per unit.
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