Previous Page Table of Contents Next Page


Module 4 - Costing and pricing


What you will learn in this module

Understand the concepts of cost
Understand the importance of pricing in business
Learn different ways of pricing a product
Apply the concepts to decision making

SESSION PLAN

Session 1

Costing: concept and practice

1 hour 30 min

Session 2

Pricing: concept and practice

2 hours

Session 1 - Costing: concept and practice

If the women understand break-even analysis, they will be able to know the level of sales at which they can cover all their costs and begin to earn a profit.

Handout 1: costing concepts

Why calculate costs?

A women's group was earning a profit of 10 000 Baht a month after paying all members for their labour. They were very happy and did not calculate the cost of production. Their product was in demand, and as long as this was so, they did not have to spend time on any calculation. Do you think this attitude is right? Is it necessary for this group to know the cost of production?

The calculation of costs is important, regardless of whether a group is doing well or not. It is only when women know how much each product costs, that they can price the product well. It is important to calculate costs, because it is possible to cut costs only by attending to details.

Women's groups often forget several elements of costing. They tend to underestimate their own labour and, therefore, the profits they calculate may be overstated. It is important that groups recognize the voluntary contributions by members. When women begin to analyse costs, they also look into the details of the process and are able to find ways in which work can be reorganized to reduce costs.

A major cost is that of raw material. For instance, in one group, each woman buys the vegetables to make herbal sweets at home and brings them to the group for sale. In another group, each woman purchases the cotton or silk raw material, weaves on her loom at home and brings the items to the group for sale. These groups can save costs if they buy the raw material together. A group that makes artificial flowers buys all their raw material (paper, glue, metal, colour) together. The simplest way to reduce cost of raw material is by making bulk purchases. This results in individual saving and also enables lower pricing of the product, making it more competitive in the market.

Thus calculation of costs helps in:

Basic concepts of costing

Costs can be classified into two broad categories:

VARIABLE COSTS

and

FIXED COSTS

VARIABLE COSTS, as the name suggests, vary according to the number of units produced. For instance, the raw material used in the production of each piece of handcraft constitutes direct cost. The bananas used in the production of banana chips, the fish used in the production of fish sauce are examples of variable costs. Raw material and labour are variable costs. Examples of other costs that vary with production level are electricity and water.

FIXED COSTS remain the same for a certain level of production. For instance, in hiring a hall with an area of 1 000 sq.feet, which can accommodate 20 looms, the same rent must be paid even if between 10 to 15 looms are operating. Therefore, women often develop strategies to spread their fixed costs. In this case, they could try to improve their market and production and install the maximum capacity of 20 looms so that their fixed costs would be optimised.

Fixed costs include rent, salaries, tools and equipment.

Break-even point

Break-even point is that level of production at which a business unit makes no profit and no loss. The level of production and sales at which the income covers all variable and fixed costs of the business is termed the break-even point.

With good planning, it is possible to reduce both variable and fixed costs. Calculating the break-even point also helps in decision-making on the level of production and sales prices. If fixed costs i.e. overheads are reduced, break-even point will be reached faster and the business will become profitable at a lower volume of production/sale. Similarly, when price is increased the break-even point is realized at a lower volume.

Handout 2: case study on costing and break-even point

The Duang Mo cooperative group of 30 women makes handicrafts from water hyacinth. Their most popular product, a basket, is a fast moving item that is in demand throughout the year.

The following information is available about the cost of production:

Tips for adaptation

This case study is on handicrafts. Examples of other products can be used depending upon the participants. The following products can be used for different credit sectors.

Wood: Wooden mobile stand

Food: Half-kilogram pack of
preserved fruit.

Textile: One metre of cotton cloth.

The group costs the product as follows:

Raw material

75 Baht

Labour charges (half a day)

50 Baht

Overheads and administration

5 Baht

Total cost

130 Baht

The price that the group charges per basket is

150 Baht

The product is sold for 250 Baht in Bangkok. The margin kept by most dealers is 10 percent, but the dealer pays a unit price of 150 Baht to this group, as this is the price that they asked for. The group believes that it is making a good profit at this sales price.

Calculate the cost of production of each basket and decide whether the group is making a good profit and a good pricing decision.

Calculating the cost

Variable cost of producing a basket in Baht

Raw material

75

Labour charges

50

Total variable cost

125


Fixed costs of production of 1 200 units in Baht

Salary of the accountant

3 000

Salary of marketing assistant

3 000

Electricity

300

Water

150

Telephone

450

Transport

900

Total fixed costs

7 800

Fixed costs per basket

(7 800 divided by 1 200) = 6.5 Baht

Thus the total cost per basket is 131.5 Baht (i.e. variable cost plus fixed cost)

Q1. Has the group made a correct calculation of cost? Is the costing of overheads and administrative cost at 5 Baht accurate? Calculate the overhead cost of the group when the production level is 1 200 units. What is the price at which the group breaks even, if it makes 1 200 units?

Solution

NO. The group did not calculate the fixed costs and charged an ad hoc amount of 5 Baht. Their fixed costs are 6.5 Baht per unit. They should charge a unit price of at least 131.5 Baht to break even.

Q2. If the price is 150 Baht, what is the quantity at which the break-even point is achieved?

Solution

If price = 150

Then contribution to fixed cost

= Price minus variable costs


= 150 - 125


= 25

How many baskets need to be sold to cover fixed costs of 7 800 Baht?

7 800/25 = 312

When does the group break even, if the price is 150 Baht?

At break-even point, total revenue (TR) is equal to total cost (TC), thus

TR

=

TC

TR

=

Price x Quantity


=

150 x Q

TC

=

Fixed cost + Variable cost


=

7 800 + 125 x Q

Therefore,

150 x Q = 7 800 + 125 x Q

or

(150 x Q) - (125 x Q) = 7 800
i.e. 25 x Q = 7 800

Therefore

Q = 7 800/25 = 312

Thus when the price is 150 Baht, break-even point is achieved at a quantity of 312 baskets.

Q3. If the price is 200 Baht, what is the quantity at which break-even is achieved?

Solution

If the price is increased to 200 Baht, the group will recover all its costs when it has sold only 104 baskets.

At break-even point, the total revenue should always be equal to total cost. Thus, if Q is number of baskets needed to be sold to recover total costs:

Total Revenue (Baht)

=

Total cost (Baht)

200 x Q

=

Variable cost + Fixed cost

200 x Q

=

125 x Q + 7 800 Baht

(200 x Q) - (125 x Q)

=

7 800

75 x Q

=

7 800

Therefore Q

=

7 800/75 = 104

The group can, in fact, charge the dealer a much higher price. As the dealer sells the product at 250 Baht and expects a normal commission of 20 percent, (s)he would be willing to pay a price of 200 Baht to the group. Thus the market can bear a price of 200 Baht, while the group is only able to realize a price of 150 Baht.

Session 2 - Pricing: concept and practice

Profit = Total revenue - Total cost
Total Revenue = Price x Number of products

Handout 1: concept of pricing

The primary motivation in starting a business is to make a profit. This is also true of a rural women's cooperative group starting a business. If the group makes a profit, it is successful in business. Whether the group makes a profit or not depends on the pricing of the product/service sold.

Therefore, one of the most important decisions that the group must take is about the pricing of the product. In order to be able to do so, members must first know the cost of the product/service. They must also know at what price the customers will be ready to buy their product/service.

Profit can be calculated using the formula below.

Profit = Total revenue minus Total costs

Profit margin = Total revenue minus Total costs of article

The price should be fixed such that it covers full costs, earns the group some profit and gives good value for money to the customers.

The following explains the concept of profit and the different ways of fixing prices.

Method 1: 'Cost Plus' pricing

The first method of fixing price, which is followed by many women's groups, is the 'cost plus' method. The women decide what profit margin they can add to the cost and fix the sales price. For instance, the cost of product is 150 Baht. They may decide to add a margin of 10 percent and fix the sales price at 165 Baht.

Total costs + Profit margin = Sales price

Method 2: Pricing at 'What the market can bear'

Another way of pricing is to price at what the market can bear.

Judging or understanding what the customer is willing to pay

+ profit margin
= sales price

Women must know the current sales price in the local market in order to calculate the price using this formula. Therefore, it is important that they know the prices prevailing in the local market. In fact, for good pricing decisions, they need to know the prices in urban markets as well.

Handout 2: case study on costing and pricing

The four-year-old Thumbole Mahardthai Women's Cooperative Group has 30 members and makes artificial flowers. The production cost of the flower made most by the group is calculated as follows:

The cost of producing 40 flowers is given in the table below:

Particulars

Cost in Baht

Labour cost at 100 Baht per day per person for five persons

500

Raw material cost for 40 flowers

530

Overheads and administration (Transport, electricity, phone bill, depreciation, packaging etc.)

370

Total cost

1 400

Cost of one flower = 1 400/40 = 35 Baht

This 35 Baht includes

Labour cost

12.50 Baht

Raw material cost

13.25 Baht

Administration costs

9.25 Baht

Total

35 Baht

Profit of margin

115 Baht

Selling price

150 Baht

Especially important for women to remember

What you have learnt in this module

Costing is important to ensure that all expenses are covered and the group fixes a price that ensures a profit.

The first and most important step is to identify ALL the costs of a business: production, sales, administrative, overheads, etc.

The next step is to classify costs into fixed and variable costs.

Break-even analysis helps with decisions regarding pricing and production levels.

Pricing can be done on the basis of 'Cost Plus' thinking and this ensures a minimum margin over costs.

Market considerations are important in pricing and are taken into account by pricing at 'What the market can bear'.

The price fixed lies within this range of possibilities. Therefore, it is important that groups calculate the costs and have an understanding of the final market for their products.

If the group depends on intermediaries such as agents, middlemen or traders, the latter's costs and profits must also be taken into account.

The services they provide include working capital advances, stocking, storage place, market information and linkages.

Marketing linkages and contacts are important to bring the group closer to its final customers.

Groups must assign at least two or three people for the marketing work so that they are constantly aware of the demand for their product, and its strengths and weaknesses.


Previous Page Top of Page Next Page