BUDGET 1 - DETERMINING YOUR SELLING PRICE & PRODUCT COST
In this Budget, you will determine your selling price (s) and your cost to purchase or produce each product you plan to sell. In other words, Budget 1 consists of Two Parts, namely,
Part 1 - Determine your Selling Price (s) Per Unit for each forecasted year; and
Part 2 - Determine your Total Product Cost (s) Per Unit for each forecasted year
Part 1 - Determine your Selling Price (s) Per Unit for each forecasted year
Part 1 of this Budget basically asks you to determine the price at which you plan to sell each of your products. The pricing methods available to assist you in setting prices include; Markup Pricing, Breakeven Pricing, Perceived Value Pricing, Hourly Rate Pricing, and Competitor Pricing. For additional information on these pricing methods, please refer to the section entitled, "Setting Your Prices".
If you plan to sell more than one product, then you will be required to develop A Weighted Average Selling Price; The process of calculating a Weighted Average Selling Price basically involves, reducing all selling prices down into one selling price.
If, however, you plan to sell only one product, having one selling price, you are not required to calculate a weighted average selling price . Since, in our Case Study, Murray Wilson is selling only one product (scholarship information on a diskette), having only one selling price, he is not required to calculate a weighted average selling price.
Lets assume, Murray analyzed his competitor's prices and his target market and determined his selling price (per unit) will be $26.00 in the first year of operation. In addition, Murray feels he should lower the price to $24.00 in his second year of operation. Therefore, Murray would develop the following chart to illustrate his forecasted selling price per unit.
200X | 200Y | |
Selling Price (per unit) | $26.00 | $24.00 |
Please Note: our example only provides a forecasted period of two years. Your forecasted period, however, should consist of three (3) years. As a result, you will be required to predict your product's selling price(s) for the third year of operation.
Part 2 - Determine Your Product Cost(s) for each Product
Part 2 of Budget 1 involves determining the cost to purchase or produce each product you plan to sell. If you plan to sell more than one product, then you will be required to develop A Weighted Average Product Cost; The process of calculating a Weighted Average product cost basically involves reducing the cost of each product you plan to sell, down into one product cost.
If, however, you plan to sell only one product, having one product cost, you are not required to calculate a weighted average product cost. Since, in our example, Murray Wilson is selling only one product (scholarship information on a diskette), he will have only one product cost, and therefore, he is not required to calculate a weighted average product cost.
Specific calculation of your product cost (per unit) will depend on whether you are a manufacturer, a retailer, or a service provider. Most retailers and service providers purchase products that are considered "finished" and ready for the public to purchase. In other words, when suppliers ship products to retailers and service providers, they require little, if any, alterations before they are sold to customers. Therefore, retailers and service providers calculate their total product cost (per unit) by determining the cost to purchase each product, plus all costs required to ship each product to their place of business, plus any other per unit cost(s) that directly pertains to the specific business or product.
Manufacturers, on the other hand, generally purchase raw materials from their suppliers (IE "unfinished" products). As you might suspect, the cost to purchase enough raw material to make one finished product becomes part of a manufacturer's total product cost. The cost to ship these raw materials also becomes part of their total product cost (per unit). In addition, manufacturers generally make substantial changes to the raw materials in order to produce one finished product. These changes usually require labor costs; better known as Direct Labor Costs ( labor directly associated with manufacturing a product). As a result, direct labor costs, needed to make one finished product, becomes part of a manufacturer's total product cost per unit.
Another cost most manufacturers must consider when determining their total product cost per unit is Factory Overhead. Factory Overhead expenditures are costs that are directly associated with operating the production facility or manufacturing plant. Examples of these costs include electricity, heat, utilities, and maintenance costs of the production facility. Other examples might include deprecation of the manufacturing facility (building) and depreciation of the production machinery and/or equipment.
The following chart summarizes the items a Manufacturer and a Retailer/Service Provider should consider when determining their Total Product Cost per unit.
COST ITEMS: | Manufacturer | Retailer/Service |
Cost to purchase each finished product/raw materials | Yes | Yes |
Shipping cost of each product or raw materials | Yes | Yes |
Direct labor cost per unit to make product | Yes | No |
Factory Overhead cost per unit | Yes | No |
Other costs relating to your particular business | Yes | Yes |
IMPORTANT NOTE FOR MANUFACTURERS:
At this point, manufacturers are not required to determine their direct labor cost per unit nor are they required, at this point, to determine their factory overhead cost per unit. For your convenience, we have established separate Budgets for each of these items; namely the Direct Labor Budget and the Factory Overhead Budget. As a result, under this section, manufacturers are only responsible for determining the cost to purchase the raw materials needed to produce each finished unit or product, and the cost to ship these raw materials to your place of business.
In our example, Murray is considered to be a retailer of information. Moreover, after developing a listing of organizations who provide students with scholarships, Murray would solicit a supplier to perform the following activities;
Lets assume, Murray contacted several suppliers and requested they provide him with a quotation on the above services. After talking to each supplier and analyzing their qualifications, Murray chose D&D Diskette Copying Services to be his main supplier. The following product costs were provided by D&D Diskette Copying Services.
Items/Services | Cost Per Item |
Cost of each Computer Disk | $0.65 |
Copying the Scholarship Info onto each Diskette | $0.35 |
Cost to Label of each Diskette | $0.25 |
Cost to Ship each Diskette to Murray | $0.50 |
Quotation per diskette | $1.75 |
Therefore, D&D Disk Copying Services will charge Murray $1.75 for each finished diskette.
Another item Murray must considered as a product cost is Packaging. Furthermore, when Murray makes a sale, he must package each diskette in either an envelop, a box, or some other container before it can be shipped to his customer. Lets assume, Murray "strikes" a deal with his supplier that states: D&D Disk Copying Services will package each product in a bubble wrap envelop for a cost of $1.25 per unit. In essence, when Murray receives a shipment of product from his supplier, each product will be prepackaged and ready for distribution to his customers.
Murray now can determine his total product cost on a per unit basis (IE per diskette). Below provides this calculation.
Items/Services | Cost Per Item |
Computer Disk | $0.65 |
Copying the Scholarship Info onto each Diskette | $0.35 |
Labeling of each Diskette | $0.25 |
Shipping Charges per Diskette | $0.50 |
Packaging Costs per unit (Envelop) | $1.25 |
Total Cost per Diskette | $3.00 |
Please Note; the cost to ship each product to Murray's CUSTOMERS will not be considered as a product cost in our example. Rather, we will assume all customers pay for shipping charges (IE to their homes).
Therefore, Murray's Total Product Cost (per diskette) for his first year of operation is forecasted at $3.00. He must now estimate his product cost for year two. In order to arrive at a product cost for subsequent years, many forecasters simply increase or decrease the first year's product cost by a certain percentage. For instance, assume Murray estimates the cost of each product will increase by 10% in year two. Therefore, the product cost in year two will be estimated at $3.30 (IE $3.00 + 10% = $3.30). The same procedure would be performed to determine Murray's estimated product cost for year three. As a result, Murray would chart his forecasted Total Product Cost in the following manner.
200X | 200Y | |
Total Product Cost (per diskette) | $3.00 | $3.30 |
Please note: our example only provides a forecasted period of two years. Your forecasted period, however, should consist of three (3) years. As a result, you will be required to also predict your product cost (per unit) for your third year of operation.
CONCLUSION:
Budget 1 is used to determine your per unit selling price and your per unit product cost. If you plan to sell only one product, then you are required to determine your single selling price and your single product cost (per unit). On the other hand, if you plan to sell more than one product, then you will be required to develop A Weighted Average Selling Price and A Weighted Average Product Cost; The process of calculating Weighted Averages basically involves, reducing all selling prices and all product costs of each product you plan to sell, down into one selling price and one product cost.
After completing this Budget, you'll be able to estimate how much you'll make from each product you sell. For instance, in year one, Murray estimates $23.00 will be made of each diskette he sells. In year two, he estimates $20.70 will be made of each diskette he sells.
200X | 200Y | |
Selling Price per diskette | $26.00 | $24.00 |
Product Cost per diskette | $ 3.00 | $ 3.30 |
Gross Margin per diskette | $23.00 | $20.70 |
After determining his per unit selling price and per unit product cost for each forecasted year, Murray can move onto Budget 2 entitled "Developing Your Sales Budget".