Identifying the actual cost of doing business requires careful and accurate
analysis. No one is expected to calculate the cost of doing business with
complete accuracy. However, failure to calculate all actual costs properly
to ensure an adequate profit margin is a frequent and often overlooked
cause of business failure.
Establishing Selling Prices
The costs of raw materials, labor, indirect overhead, and research and
development must be carefully studied before setting the selling price of
items offered by your business. These factors must be regularly
re-evaluated, as costs fluctuate.
Regardless of the strategies employed to maximize profitability, the method
of costing products offered for resale is basic. It involves four major
categories:
* Direct Material Costs
* Direct Labor Costs
* Overhead Expenses
* Profit Desired
Combining these factors allows you to calculate an item’s minimum sales
price, which is described below:
1. Calculate your Direct Material Costs. Direct material costs are the
total cost of all raw materials used to produce the item for sale. Divide
this total cost by the number of items produced from these raw materials to
derive the Total Direct Materials Cost Per Item.
2. Calculate your Direct Labor Costs. Direct labor costs are the wages paid
to employees to produce the item. Divide this total direct labor cost by
the total number of items produced to get the Total Direct Labor Cost Per
Item.
3. Calculate your Total Overhead Expenses. Overhead expenses include rent,
gas and electricity, telephone, packing and shipping, delivery and freight
charges, cleaning expenses, insurance, office supplies, postage, repairs
and maintenance, and the manager’s salary. In other words, all operating
expenses incurred during the same time period that you used for calculating
the costs above (one year, one quarter, or one month). Divide the Total
Overhead Expense by the number of items produced for sale during that same
time period to get the Total Overhead Expense Per Item.
4. Calculate Total Cost Per Item. Add the Total Direct Material Cost Per
Item, the Total Direct Labor Cost Per Item, and the Total Overhead Expense
Per Item to derive the Total Cost Per Item.
5. Calculate the Profit Per Item. Now, calculate the profit you determine
appropriate for each category of item offered for sale based on the sales
and profit strategy you have set for your business.
6. Calculate the Total Price Per Item. Add the Profit Figure Per Item to
the Total Cost Per Item.
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