Any profit making business is established with the only aim of earning profits. Whatever the nature and kind of product and organization embarks to sell they have to invest a certain amount of money either towards fixed assets or variable assets or both. This expense incurred by a businessman to produce goods and services is known as “the cost of production”. Cost of production includes purchase of material, land, manpower, advertising & marketing etc.
Every businessman has to estimate the expenses on both fixed and variable assets for finding the profit or loss at the end of financial term. It is empirical for every business to consider its production budget and product pricing before entering the market. A production budget depicts the capital available for production on launch. It helps in developing a strategy for production. According to the availability of capital a businessman decides whether to start production on large scale or small scale. Usually the best policy is to start producing in small scale for testing the product market and observing consumer response.
Consumer’s response is based on the products pricing for if the product is highly priced it becomes expensive for consumers and if the same product is priced low it leaves a low margin for businessman to continue production. Moreover, a low priced product at times arouses doubt in consumer’s mind for its quality.
Sensible product pricing requires understanding of the elements of cost namely material, labor and expenses. The material, labor and expenses that contribute directly towards production together make “Prime Cost”. There are costs that are incurred in form of overheads and other indirect expenses during production. These indirect costs of material, labor and expenses added to the prime costs make “Total cost of production”. Selling price of a product is calculated by adding profit to the total cost of production.
Total Cost = Prime Cost + Indirect expenses
Selling price = Total cost + profit
Business requires regular monitoring of activities especially financial. A comprehensive Cost control exercise ensures that finances are utilized in most economical and efficient manner.
