How To Set A Sales Price For Your Product Or Service
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Fixing the selling price can be based upon a value basis or a cost plus basis
with either basis subject to modification according to market conditions. Not
exactly scientific and true in all cases but the most profitable businesses tend
to be managed by accountants while the best sales growth companies have a sales
oriented manager at the helm.
Value basis is used to set selling prices according to the amount the
customer will pay for the product and the value of products or services being
provided. A strong influence when using a value basis are the benefits a
customer will derive from purchasing the product from each business compared
with alternative suppliers and the general market rate for that type of product.
Using a value basis that prices products above the general market level
requires support and a marketing strategy to demonstrate to the market place the
benefits and advantages a prospective client receives. Pricing a product or
service below the accepted market price requires to be supported with ensuring
as wide an audience as possible is aware of the bargain prices and the reasons
why a lower price is being offered.
To establish the most profitable level at which selling prices should be
pitched it is important to conduct market research to determine the general
level of pricing within the product area. Also list the benefits and advantages
within the context of other competitive products of the specific products being
offered to enable the business to use these factors in support of the price
To maximum level at which value basis prices can be set is dependent upon the
value the target customer places on that product or service taking into
consideration the quality, service, availability and benefits provided.
Cost based pricing is a financial accounting calculation based upon fixing a
gross profit margin that the business requires given the expected sales volume
and fixed overhead or operating costs to produce a net profit. Normally a sales
price set using a cost basis would be the amount paid for the product plus an
Cost based pricing usually occurs in areas where competition is often working
on the same cost basis and by selling similar products and services the volume
of sales is sensitive to competitive prices. Market research should establish
the range of competitive prices.
There are a number of influences that impact on setting the selling price of
a product in addition to the cost and competition. Sales location, added values,
buying policy, operational costs and others all require factoring into the
calculation. Business size also has an influence as small business accounting is
less sophisticated than accounting and financial control in larger businesses.
The tow single most important factors in setting the selling price of a
product or service to generate the highest profit margin attainable are the
competition and the original cost of the product.
In many cases the existing competition has already set a price for the
product. Each business has to decide whether to accept this price according to
the expected volume and the gross profit margin generated or charge a higher or
lower price with the consequential effect on sales volume.
The purchase price paid drives the competitive edge. Larger business have
greater opportunities to buy in larger quantities and obtain cheaper prices and
many high volume businesses will search to source products from overseas markets
to obtain even cheaper products.
If the purchase price paid by competitors is low then that cost must be
either matched by adopting similar business practises or the products sold into
a niche area of the market where more flexible prices can be obtained at the
required volume to generate the gross margin required to cover fixed operating
costs and achieve the target net profit.
Different prices can be set for different customers to exploit higher profit
margins where possible and achieve higher volumes in market conditions where the
price has a major influence on quantities bought. A manufacturer will often set
different prices for each customer dependent on volumes purchased and the
negotiation skills of the client purchasing function.
Market conditions often determine a range of pricing policies including
offering quantity discounts for higher volumes, cash discounts for faster
settlement, lower than normal prices to allow a market to be penetrated and
established more easily and higher than normal prices in situations where supply
may exceed demand. The accounting software or bookkeeping system employed should
identify gains and losses due to different pricing structures.
The levels of supply and demand may change over time and a flexible pricing
policy to take advantage of these changes is desirable. It is an economic fact
that when demand exceeds supply prices will increase and when supply exceeds
demand prices go lower. Failure to react quickly has a major impact on the total
gross margin attained.
The overriding decision to be taken on setting selling prices is the amount
of gross profit generated by the sales volume of those products in relation to
current business policy and fixed operating costs and profit requirements that
business needs to achieve and demonstrate through the accounting figures
produced by the final bookkeeping reckoning...
From an accounting point of view the sales volume and price of each product
should be calculated to determine the previous gross profit margin attained and
planned for the future. The actual or forecast gross profit margins must cover
the fixed operating costs of the business or remedial action taken to ensure the
business is profitable. Setting prices is a combined decision of the sales and
About the Author
Terry Cartwright, accountant at DIY Accounting, designs UK Accounting
http://www.diyaccounting.co.uk/ providing accounting solutions for small to
medium sized business and bookkeeping software at
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Article Published/Sorted/Amended on Scopulus 2008-03-07 07:14:35 in Business Articles