Price cal­cu­la­tion: How to calculate cost of sales

It’s best to calculate your pricing as part of your business plan. To do this ef­fec­tive­ly, you need a precise and well-thought-out cal­cu­la­tion that considers key factors to determine the optimal price for your product or service.

How to calculate the sales price step by step

Price cal­cu­la­tion depends on several important factors. Along with ac­qui­si­tion and man­u­fac­tur­ing costs, the market en­vi­ron­ment and com­pe­ti­tion play a key role. What are your com­peti­tors charging, and what prices are your customers willing to pay?

Step 1: Target group analysis

First, focus on those who will ul­ti­mate­ly pay the cal­cu­lat­ed price: your potential customers. As part of market research, analyze who your product is suitable for and identify the char­ac­ter­is­tics of this group. In­for­ma­tion such as gender, age, marital status, income, oc­cu­pa­tion, education level, as well as interests and desires, help define your target audience. Based on these char­ac­ter­is­tics, you can estimate how much money potential customers have available for your product and how much they are likely willing to pay.

You can estimate your target group’s will­ing­ness to pay through surveys and analysis of past sales. Pay close attention to the reasons provided by re­spon­dents and the feedback from your customers, as these insights are par­tic­u­lar­ly valuable. With this in­for­ma­tion, you can define a price range that aligns with your audience’s ex­pec­ta­tions. The extent of the survey will depend on your available resources. For instance, while large-scale studies may be out of reach for many en­tre­pre­neurs and small busi­ness­es, mean­ing­ful insights can still be obtained by engaging 10 to 20 carefully chosen par­tic­i­pants.

Step 2: Com­peti­tor analysis

If you know that your potential customers are the­o­ret­i­cal­ly willing to pay for your new product, then you should also gather and evaluate in­for­ma­tion on the com­pe­ti­tion. No one will offer the exact same product or service as you, otherwise you wouldn’t need to bring your idea onto the market. Nev­er­the­less, there will be providers of products and services that are at least very similar. It’s important to consider what chal­lenges they pose to your business, and what their price/per­for­mance ratio is. In addition, it’s not just the product that plays a role – ad­di­tion­al services such as a support hotline also need to be factored in.

Step 3: De­ter­min­ing the cost

When you calculate sales prices, you must of course check whether you could actually cover all the costs at the de­ter­mined price. This involves adding together the different cost cat­e­gories to get the total cost:

• Material costs: Producing your product typically requires pur­chas­ing raw materials, operating supplies, and auxiliary materials.
• Man­u­fac­tur­ing costs: These include the wages of employees who man­u­fac­ture the product, as well as expenses for machinery and storage.
• De­vel­op­ment costs: De­vel­op­ing your product or service took time and money, however, experts recommend against directly in­cor­po­rat­ing these costs into the final price, as it could make the price un­rea­son­ably high.
• Service costs: De­liv­er­ing the service, as well as ac­tiv­i­ties like con­sult­ing and trans­port­ing products, generates ad­di­tion­al expenses.
• Sales costs: Marketing and sales also incur costs, which should be factored into your pricing cal­cu­la­tion.
• Ad­min­is­tra­tive costs: Back­ground op­er­a­tions, such as ac­count­ing, also generate expenses.

The various types of costs can be broadly divided into two cat­e­gories: direct costs and overhead costs. Direct costs are those directly as­so­ci­at­ed with each in­di­vid­ual product, such as material costs—for example, the exact number of screws required for a piece of furniture. Overhead costs, on the other hand, cannot be at­trib­uted to a specific product but are dis­trib­uted across all products produced. An example would be the costs of pur­chas­ing and operating a saw, which are allocated to the prices of all tables man­u­fac­tured with it.

When you sum up the direct costs and dis­trib­ute the total overhead costs across all cost carriers, you arrive at the total pro­duc­tion cost of a product or service.

Step 4: Profit margin

Since the aim is to turn a profit on your product or service, rather than simply break even, you must now decide on a profit margin. When doing this, many en­tre­pre­neurs make the mistake of orienting them­selves too heavily on the common industry margin. This may cause them to miss out on the pos­si­bil­i­ty that customers were actually willing to pay a higher price. If you have already re­searched the price your potential customers are likely willing to pay, it is easier to estimate how much you can add to the prime costs.

Step 5: Discounts

Set your list price to ensure prof­itabil­i­ty even during future discount campaigns. To prevent short-term price re­duc­tions from cutting into your profits, include the discount in your initial price cal­cu­la­tion. Likewise, factor in any cash discount—a price reduction offered for payment within a specific timeframe—when creating your pricing strategy. While discounts often range from 5 to 50 percent, cash discounts are typically set at 2 or 3 percent.

How do you price a product? Formula and approach

Let’s walk through all the steps mentioned earlier with a concrete pricing example. Our example en­tre­pre­neur has developed an in­no­v­a­tive chair made from a material that has never been used for chairs before. During the target audience analysis, the founder dis­cov­ered that potential customers respond well to the new product and are willing to pay up to $100 per item. The market analysis revealed that prices for high-quality chairs from other providers range between $80 and $120.

Now it’s time for the cost cal­cu­la­tion, where all in­di­vid­ual factors are added up. The raw material plays a par­tic­u­lar­ly sig­nif­i­cant role here. In addition to the founder, two employees are involved in the pro­duc­tion of the chairs. Costs for machinery, pro­duc­tion and storage fa­cil­i­ties, office work, logistics, and marketing are also included. The en­tre­pre­neur adds a profit margin of 35% and a discount of 15% to these pro­duc­tion costs. As a new business, the company aims to attract customers with com­pet­i­tive pricing, es­pe­cial­ly in the beginning.

Even with a rel­a­tive­ly high profit margin of 35% and an included discount of 15%, the list selling price of $70 is still below the $100 that customers are likely willing to pay. In the following year, the company might be able to increase sales, which would reduce overhead costs and further boost profits.

What to be mindful of when cal­cu­lat­ing sales prices

In­ex­pe­ri­enced en­tre­pre­neurs, in par­tic­u­lar, often make the same mistake when cal­cu­lat­ing a price. For example, setting the price too low and jeop­ar­diz­ing their entire business as a result. This is because once the sales price is set too low, it is difficult to change it again. Customers are usually not best pleased about price increases – es­pe­cial­ly when the product or service doesn’t have any new features or im­prove­ments. So that you don’t fall into the same traps, we’ve listed the most common mistakes for you.

• Trusting your gut feeling: Too many en­tre­pre­neurs rely solely on their instincts when cal­cu­lat­ing prices, often leading to incorrect estimates. A precise pricing cal­cu­la­tion helps avoid un­pleas­ant surprises.
• Over­look­ing costs: Cost de­ter­mi­na­tion is highly complex, and many items are often over­looked initially. Take your time with the cal­cu­la­tion.
• Mis­judg­ing demand: It’s crucial to base your cal­cu­la­tions on realistic sales figures. If you can’t sell your entire inventory, the cal­cu­la­tion won’t work.
• Gen­er­at­ing excessive costs: Some en­tre­pre­neurs aim to launch the perfect product, which often comes at a high price—too high for the target audience. This is why a target audience analysis is essential from the start.
• For­get­ting your own earnings: Your work as an en­tre­pre­neur must also be com­pen­sat­ed. The selling price should cover this as well. Keep this in mind when cal­cu­lat­ing prices.
• Not ac­count­ing for vacation and sick days: Es­pe­cial­ly if you’re an SME offering services, you need to factor in vacation and sick days when de­ter­min­ing the selling price.
• Creating overly complex revenue models: If you’re not simply offering products or services at a fixed price but, for instance, im­ple­ment­ing a sub­scrip­tion model, be aware of the con­se­quences. Carefully consider whether each pricing option is fi­nan­cial­ly viable.

Please note the legal dis­claimer for this article.