Pricing & Costing: including budgeting & life cycle costing
Anjana [email protected]
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ExerciseRevenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000
What is the profit margin ??
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ExerciseRevenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000
What are your thoughts on the profit so calculated?
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ExerciseRevenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000
Do you think this is the true profit? How has indirect cost been calculated
(allocated)? What are your views on the costing?
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ExerciseRevenue- Restaurant A – Rs. 10,00,000
Restaurant B – Rs. 4,00,000Direct - Restaurant A – Rs. 6,00,000
Restaurant B – Rs. 2,20,000Indirect - Restaurant A – Rs. 2,00,000
Restaurant B – Rs. 80,000
How does change in basis of allocation impact profit ?
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SolutionCase I
Amt Rs.
Restaurant A B Total
Revenues 1,000,000 400,000 1,400,000
Direct 600,000 220,000 820,000
Indirect 200,000 100,000 300,000
Margin 200,000 80,000 280,000
% margin 20 20 20
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Alternate scenarioCase II
Amt Rs.
Restaurant A B Total
Revenues 1,000,000 400,000 1,400,000
Direct 600,000 220,000 820,000
Indirect 150,000 150,000 300,000
Margin 250,000 30,000 280,000
% margin 25 7.5 20
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Costs Costs are incurred in a variety of
functions in business–Establishing business–R&D–Production / Delivery of service–Sales and marketing–After sales service–Administration
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Importance of costing
Planning Controlling Decision making Implementing Continuous improvement
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Costs: Analysis Useful to decide what is controllable
and what is not Helps to understand what is relevant
to decision making Must be done with care to avoid
incorrect decisions
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Relevant costs Expected future costs to help in making
decisions Differ with alternate courses of action
– Managers make decisions based on costs allocated
– Managers may make short run decisions that may affect long term business and sales
Relevant costs help choose between alternatives
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Costs - relevant / not relevant
Equipment replacement–Book value of old equipment – not
relevant–Current disposal price of old equipment
– relevant–Cost of equipment - relevant
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Break even point Ram Kumar wants to sell Computer
tables and chairs at a conference stall He estimates that he can sell each unit
for Rs. 10,000 each The cost per unit is Rs. 6,000 The stall rent is Rs. One lakh How many units must Ram Kumar sell to
break even?
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Break even point In continuation of the previous example,
assume that Rs.6000 is not cost, ie assume some raw material which is anyway spare – eg. wood, is used for this purpose. So this cost actually may not be relevant, thou labour cost may be relevant then what happens to your decision?
Try to develop a different perspective and way of thinking
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Costs: Analysis
Identify cost objects / cost centres Accumulate costs Assign / trace costs to cost objects
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Assignment / Allocation
Selection of Activity base – people; machine hours;
material consumed Activity level – normal/abnormal
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Budgets Plan performance in advance for a
given time frame Review performance with budget Understand reasons for variation Take remedial measures if required Plan again based on actual
performance and feedback
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Budgets Master budget, comprising of
detailed budgets for eg. budgets for – Income–Production–Direct costs–R&D–Administration
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Product budget Expected sale Inventory on hand Production schedule Direct costs Indirect costs Company policies and strategy
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Life cycle costing Considers entire life cycle of product from
start to finish Provides important information for pricing
decisions For example, if a mobile phone is built, if
the R&D costs are high for the company, the repairs and maintenance cost to the customer may be low; so the life cycle is across the life of the product and considers costs and impact on prices
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Life cycle costs Upstream costs
–R&D, design, prototyping, testing, quality development
Manufacturing/Operations costs–Purchasing, manufacture/service
Downstream costs–marketing, sales and distribution,
customer service and warranty
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Life cycle costs Product life cycle costs vary with
industry and nature of industry R&D is not only at start of product
life, this may also occur at other stages, ie development of additional features in product
Life cycle may also depend on markets targeted, ie country, region, socio-economic background etc.
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Implementation of LCC Identify stages in product life cycle Identify target customer Understand target customers
perspective and estimate need Analyse cost and pricing in detail Educate employees about LCC
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Implementation of LCC Develop product and pricing structure
based on LCC Create appropriate organisation structure
for implementation Educate customer on LCC, eg. mobile
phone referred to in earlier slide Focus on strategic marketing to address
customer requirements and needs, stated and unstated
Continuous life cycle budgeting and monitoring and modify/change as required
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Life cycle costing benefits
Optimisation of profit over product life
Full set of costs associated with products are ascertained–Most accounting systems capture
manufacturing costs–Other areas like R&D at start and
customer service as close do not get much importance
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Life cycle costing benefits
Differences in percentages in committed costs at initial stage of business is highlighted–The higher the initial costs, the more
critical it is for management to develop better predictions about revenues
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Life cycle costing benefits
Interrelationships across cost categories are highlighted–Many companies with high R&D &
product refinement costs may experience less customer service costs and vice versa. Such costs are often hidden and affect quality of product
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Pricing decisions
Influenced by Costs Competitors Customers Time horizon – short run or long run
decisions Strategic reasons
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Target Pricing Develop product Set target price Try to achieve target cost
Target cost = Competitive price – desired profit
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Pricing for short run Decide on relevant costs that should be
used Compute costs, direct, indirect and total Compute any special costs that need to
be incurred and savings that may be possible
Decide on pricing based on other factors such as long term impact, competition etc.
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Pricing for long run Important to consider long term
pricing for long term sustainability and growth of business
Initial pricing and short term pricing should keep long term pricing in mind
Image and brand of business to be considered in pricing
Costs to be understood and allocated Consistency in pricing in long term
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A cup of coffee A cup of coffee costs Rs. 10 to make
HOW will you plan to price this?
……….. continued..
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A cup of coffee
Will you charge based on the price of coffee in similar coffee shops and restaurants?
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A cup of coffeeFor example …
You could charge differently during the rush hour
You could have special rates in non rush hours