Before determining the price for a product, one needs to determine the cost of the product and take into consideration the break even point. The break even point is the point at which the retailer neither makes nor loses any money in producing a product or delivering a service.
The break even analysis is the process used to uncover the break even numbers. The first step towards arriving at the break even point is to determine the fixed and the variable costs at different levels of purchase or production.
Before calculating the break even point, it is necessary to determine the fixed and the incremental cost per unit (variable costs).
To calculate the break even point i.e. the point at which the business will neither make a profit or a loss the following formula can be used:
Break even Revenue = Fixed costs / 1 – (Variable cost per unit / Selling Price per unit)
Example: Calculating break even Revenue
As an example, let’s try to determine an appropriate hourly rate (revenue) that can be charged by a consultant or service business.
The total fixed costs are Rs 40,000 variable cost per unit Rs 25 (per hour) and the selling price of Rs 50. Using the break even formula, the revenue can be determined as:
= 40,000 / 1 – (25 / 50)
= Rs 80,000
So, this company needs revenues of Rs 80,000 to cover its cost. If it doesn’t have enough business at these rates, it loses money by being in business. If it makes more than Rs 80,000 in revenue it’s, making money.
Calculating Break even Units
To determine how many units must be produced and sold to break even use the following formula:
= Fixed costs / Unit Contribution Margin *
= Number of units needed to break even
*Where Unit Contribution Margin = Selling Price per Unit – Variable Cost per Unit.
Example: Calculating Break even number of units
The unit produced in this example is one hour of consulting. In our example, the number of hours required just to cover costs is 1,600.
40,000 / 50 – 25
= 1600 units (hours per year)
Mark up Pricing:
The markup is the difference between the costs of the product and the final selling price. The mark up can be in rupee terms or it can be in terms of a percentage. Mark ups can also be calculated on the cost of a product or on the retail price.
A markup can be expressed as either a rupee amount or as percentage of the selling price.
A rupee markup occurs when the retailer adds a fixed amount to the cost of the product.
Markup % (at retail) = (Retail Selling Price – Merchandise Cost) / Retail Selling Price
Markup % (at cost) = (Retail Selling Price — Merchandise Cost) / Merchandise Cost
The two concepts of mark up can be understood with the help of a simple example given below:
A buyer pays Rs 100 for a toy to be sold in his store. He intends selling the toy at a price of Rs 175. Thus, the retailer’s percentage markup on cost would be calculated as given below:
Mark up percentage at cost = 175 – 100 / 100
Markup percentage at retail price = 175 – 100 / 100
The Cumulative Markup is calculated for a group of products.
The cumulative markup would be calculated as under:
Markup% at retail = Retail value–cost value / Retail Value
Initial Mark up:
Initial mark up is the difference between the cost price of the merchandise and the initial retail price. The initial markup takes into consideration the operating expenses, the planned profit, the shortages in stock, etc.
It can be calculated as under:
Initial Mark up % = ( Operating Expenses + Net Profit + Mark downs + Stock shortages +Employee & Customer discounts+ Alteration costs–cash Discounts) / (Net Sales + Mark downs + Stock shortages + Employee & customer discounts).
Maintained mark up:
The maintained mark up is the different between the gross merchandise cost and the actual selling price.