Estimating Product Costs

Ever wondered what is so important about estimating product costs?

One of the steps involved in working out the profit potential of your new business will be estimating product costs. You need to do this so that you are able to:

• Evaluate the profit potential of your business model,
• Investigate your small business pricing options and select an appropriate price for each of your products, and
• Calculate the contribution margin on each of your products.

On the previous pages, you have read about the difference between variable costs and fixed costs.

On this page we will be concentrating on allocating your direct or variable costs to individual products. If you skipped these pages, I suggest you go back for a quick look, it will make it easier to follow the information on this page.

Product Level Costs?

If you are a retailer or a drop shipper, calculating your product level costs will be very easy. Basically you just add together the purchase price with any costs you have incurred to purchase the product.

For example if you buy a particular product at a price of $5.95 per unit in lots of 10, the freight costs $25.00 per order, and there are no other costs related to the purchase or sale of the product, your product level cost will be $8.45 (see calculation below).

But what if you are a manufacturer?

Depending on the complexity of your product, you can just about guarantee that your costing model will be much more complicated.

Click here to take a look at some examples of product cost calculations. These are product cost calculations for real products, produced by a local company that I did some costing work for recently.

Feel free to have a look. I have included three examples in the file, one for a product with low levels of complexity (a set of bed slats), one with a moderate level of complexity (a bookcase), and one with a high level of complexity (a hall stand).

What to Include When Estimating Product Costs?

To calculate your product level costs you will need to identify all of your inputs plus any costs that you incur to convert those inputs into a viable product.

• Raw materials,
• The cost of inward freight,
• Consumables,
• Labor costs,
• Machine running costs, and
• Machine set-up costs.

Don't forget to include the costs of any of the production work that you have outsourced to other firms (like the cost of polishing the timber furniture in the examples provided above).

Allocating your Fixed Costs

Basically to recover the total cost of production you need to spread your fixed costs across all of your products. The simplest allocation form is to divide total fixed costs by the number of products you intend to produce or sell and apply that amount to each unit.

For example, if your total fixed costs amount to $20,000 per annum and you plan on selling 50,000 in the first year, you would allocate $0.40 to the variable or product level cost of each unit.

There are more accurate methods of allocation (job costing or activity based costing methods) but these are outside the scope of this discussion for now.

	Enter your search terms Submit search form
	Web www.how-to-start-a-small-business.com

Return to top of Estimating Product Costs

Return to top of Startup Profit Potential

Home | Privacy Policy | Contact