Costing and pricing of Goods and

services
Mr. M. MOADI
 COSTING
Financial management is about the efficient and effective use of funds in a
business in order to generate enough profit and keep the business going.
Money is the life blood of a business. If a business runs out of money, it
will not be able to settle its bills (materials, labor, loan repayments, rent,
etc.). And it will not be able to buy new machines and equipment.
The following are common pitfalls in cash management:-
a) Poor costing of products/services
b) Poor pricing
c) Poor maintenance of business records to monitor and control
movements of money in the business
d) Poor collection of debts
e) Overstocking products and materials due to poor marketing skills
f) Withdrawing cash excessively for personal use.
 COSTING
The reason for teaching Costing and Pricing are as
follows:
• to emphasize the importance of costs in a business and
how to price products profitably
• to introduce simple methods of classifying and
calculating costs
• to introduce factors that should be taken into account
when pricing products or services.
• to give an understanding of the relationship between
costs and price of a product.
 COSTING

The cost of a product or service is the total

expenditure incurred to produce and sell that
product or service.
Costing is the way you calculate how much each
individual product or service costs you to
produce and sell.
 COSTING

Good knowledge about the business’ costs will help you

to:-
• set prices or give estimates of price and know if you
are making a profit or loss.
• find out which items are most costly in the running of
the business, and see if it is possible to reduce the
costs.
• see what is the effect on your costs of any
improvements you are planning and if the business
can be more efficient.
 COSTING

The information that you need for your costing

comes from your book-keeping system. You
need documents such as payrolls, time-sheets
and invoices. For this reason it is important that
you maintain your book-keeping system in good
order
 TYPES OF COSTS

In any business there are two types of costs:

• Direct Costs
• Indirect Costs (overheads)
Thus direct costs + indirect costs = total costs
Direct costs are the costs of those items that
become part of the product or service that you
produce. These are:
 TYPES OF COSTS
• raw materials and parts (material cost)
• wages paid to the workers for the time they
spend making the product (labor cost)
Overheads (Indirect costs): are the cost of all
the other items which you need to run your
business. These include:
 TYPES OF COSTS
• the use of buildings, machines and equipment
(rent, maintenance)
• utilities, insurance, advertising, taxes, etc.
• Depreciation – this is the reduction in value of
a fixed asset (building, machinery, etc.) due to
either physical wear and tear, obsolescence or
the passage of time.
 CALCULATING COSTS FOR A PRODUCT
Consider a carpenter making tables. He has five production workers and a
supervisor. Each worker gets 600/month and the supervisor gets 900/month.
A. DIRECT LABOUR COST
i) 5 workers x P600=P3000/month

ii) Plus 1 Supervisor x P900=P900/month

Total= P3 900/month

iii) Total Annual wages bill, = P3 900 x 12=P46 800

iv) Annual wage bill for production workers = P3000 x 12 = P36 000
 CALCULATING COSTS FOR A PRODUCT
v) Calculate the total number of hours which will actually be
worked during the year by the production workers. Previous
year’s records can assist you in this exercise.
Suppose the workers work 36 actual hours per week and 40
weeks per year.
Total hours worked per year = 40 weeks x 36 hours x 5 workers
= 7 200 hours
vi) Labor cost per hour = Annual Production Workers Wage Bill
Total hours per year
 CALCULATING COSTS FOR A PRODUCT

For our carpenter entrepreneur, labour cost per

hour is: 
P36 000 = P5/hr
7 200hrs
vii) Assume 10 hrs. will be spent by your workers
to make one table.
viii) Total Direct Labor Cost per table =P5 x 10
hours = P50.00
 CALCULATING COSTS FOR A PRODUCT
(i.e. Total no. of hours x hourly labor rate = Direct labor cost per
table)
DIRECT MATERIAL COSTS
To calculate the direct material costs for one table you simply
add up the costs of all the materials and parts that are used in
making the table. These costs must include the pieces wasted.
 CALCULATING COSTS FOR A PRODUCT
Total Direct Material Costs per Table
QUANTITY ITEM PRICE TOTAL

1.7m² black board P198/m² P336.00

0.023m³ hardwood P35.20/m³ P 80.96
      P416.96
  + 10% waste   P 41.70
0.125L glue P61.40/L P 7.68
0.062kg panel pins (1 ) P33.60/kg P 2.10
0.125L clear varnish P93.00/L P 11.63
2 sand paper P3.50 each P 7.00
 

Total material cost per table   P487.10

CALCULATING COSTS FOR A PRODUCT
INDIRECT COSTS
Carpenters have many expenses other than the direct costs of
making tables. They must repair their workshops, maintain and
service the machines, run an office, pay interest on loans, sell
the tables, and deliver them. These are the indirect costs.
Parts of these indirect costs have to be included in the cost of
each table. To calculate the indirect costs for one table, you first
have to make an estimate of the total indirect costs for the year.
CALCULATING COSTS FOR A PRODUCT
You can estimate the total indirect costs in your business by
finding the figures for all the indirect cost items from your last
year’s accounts and adding them up. Add on a percentage which
you think will cover the increase in prices which will result from
inflation, e.g. 10 percent or 20 percent. In the example below
we use a rate of 20 percent inflation.
If you do not have last year’s figures available write down each
item of indirect costs and try to estimate how much you will
spend on each of these items. Try to remember how much you
spent on each item last year
CALCULATING COSTS FOR A PRODUCT

Assume that the figures for indirect costs in the

carpenter’s workshop were as follows, and that
20 percent was added to cover inflation:
 CALCULATING COSTS FOR A PRODUCT
LAST YEAR’S FIGURES
  Per month Per year
Supervisor’s salary P900.00 P10800
Interest on loan P100.00 P1 200
Rent of building P500.00 P6 000
Power and electricity P100.00 P1 200
Telephone P250.00 P3 000
Maintenance of machines and equipment   P 200
Depreciation of machines and equipment  
(value = P10,000) P2 000
  P24 600
Add : 20% inflation (as applicable) 4 920

Total overheads for the year   P29 520

CALCULATING COSTS FOR A PRODUCT
Since we had earlier assumed that it will take 10 hrs to make one table, the
carpenter should expect to produce 144 tables. This number is derived as
follows:
Number of tables expected to be produced

= Number of working hours for the year

Number of hours it takes to produce one table

= 40 weeks x 36 hours
10 hrs
 
= 1440
10

= 144 tables
CALCULATING COSTS FOR A PRODUCT
Indirect Cost per table: 
Total overheads for the year
number of tables produced 
= P29 520
144
= P205
CALCULATING COSTS FOR A PRODUCT
Total Costs per table:
Direct labor cost (a) + Direct material cost (b) + overheads (c)=
P 50.00+ P487.10+ P205=P742.10
The calculated cost per table is called a standard cost. This is a
pre-determined calculation of how much costs should be, under
specific working conditions.
 PRICING OF PRODUCTS AND SERVICES
The price of a product or service is the amount of money you
charge your customers for your product or service. The price
must include all of the costs you incurred to produce and sell the
product or service, and a profit.

PRICE = TOTAL COSTS + PROFIT

In our example, the total cost of a table is P742.10.
If we assume that the carpenter intends to make 100% profit,
then the price of one table is:
Price = P742.10 + P742.10 = P 1484.20
 PRICING OF PRODUCTS AND SERVICES
If we assume that the carpenter intends to make 20% profit,
then the price of one table is:
Price = P742.10 + P148.42 = P 890.52
Many small businesses fail because of the owner-managers’
inability to analyze all the costs and build them into the price. All
the costs (direct labor, direct materials and overheads) must be
included in the price. If you charge lower prices make sure that
you include all costs of production and selling your product or
service.
 PRICING OF PRODUCTS AND SERVICES
There are other important factors which you must take into
account when pricing your products. These are:
• Customer’s Perception:
The price that customers are willing to pay may depend on their
perception or opinion of the value of what the product or service
can do for them. If the customer’s perception is that the product
is worth P10, you will have real problems in convincing him that
it is worth P20.
 PRICING OF PRODUCTS AND SERVICES

• Competition:
Competition is a major factor in setting prices. If two
similar products (from different manufacturers) are laid
side-by-side on a shelf, chances are the customer will
choose the one that is cheapest. If your product is the more
expensive one, you will have to convince the customer that
your high-priced product is really worth it. On the other
hand if your price is lower than your competitors’, you will
have to convince your customer that product is good
enough.
 PRICING OF PRODUCTS AND SERVICES

• Customers Demand:
If you can sell everything you produce, you have
little reason to keep prices low. But if demand is
low, you may have to keep your prices low in
order to get enough sales (all costs must be
covered and a profit made).
 PRICING OF PRODUCTS AND SERVICES
Pricing Procedure
After careful consideration of the above factors you
should be in a better position to determine the price for
your product or service.
• First, your costs should set the floor for your pricing
system.
• Second, your competitor’s price should set the ceiling.
• Third, you must ask yourself:-Where between these
limits should I set my price?
 PRICING OF PRODUCTS AND SERVICES

EXAMPLE: Consider the food vendor Mr. Mopipi

setting a price for his fat cakes.
Price

75 thebe ceiling (set by your competitor’s prices)

50 thebe- your price

40 thebe The floor (set by your costs)

0
Quantity of fat cakes