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What is the Cost plus pricing method?
In Cost plus pricing method, a fixed percentage/profit margin is added to unit production cost which includes material cost, labour cost, overheads cost, manufacturing overheads etc. to get selling price.
This type is more suitable, where there is no uniform production or each order is different.
The formula for cost plus pricing method is as follows −
S.P. = PC (1+ PM)
Here, S.P. = Selling price, PC = Unit production cost, PM = profit margin/fixed percentage
The advantages of cost plus pricing method are as follows −
- Simple to calculate.
- Increase in price can be justified.
- Price can be determined, if there is no market price.
The disadvantages of cost plus pricing method are as follows −
- High prices.
- Replacement costs are ignored.
- Market competitions are ignored.
- No contract cost.
Consider an example given below wherein the cost plus pricing method is used.
If a power plant company generates 90000 units, which consumes 25000 litres diesel (costs $1/lit). Through this, the company earns $35000/month and management fee $23000. During the contracting period of eight years, it depreciates at $ 10000/month.
(Assume profit margin = 25%, sales = 23%).
The profit with the help of cost plus pricing method is calculated as shown below −
Total cost = diesel cost + labour cost + management fee + depreciation
= 25000 + 35000 + 23000 + 10000
Invoice = total cost (1+ profit margin)
= 93000 (1+ 0.25)
Profit = 116250 – 93000 => $ 23250
Sales invoice = 93000/ (1-23%)
= 120779 (approximately)
Profit = 120779 – 93000 = $ 27779
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