Sales price formation: Definition & Examples

Launching a product or service on the market requires knowledge so that the price charged is the most appropriate for the reality of the company and potential customers.

To offer the best price on the market, it is possible to monitor the competitors that are already installed and identify if the price is compatible with the expected profit.

It is important to take into account the costs that the company will have to produce and make available such a product, since the unit price must be higher than the total costs and expenses.

In addition, it is necessary to differentiate them into fixed costs, such as those with rent and employees, and variable costs, which are directly linked to the commercial activity.

In general, the sale price is defined by the sum of the costs and expenses, including taxes, plus the profit you want to obtain:

Selling price = Costs + Expenses + Expected profit

Below we present the most appropriate ways to analyze and calculate the prices that can be charged for products or services.

How to calculate the sale price through  markup

The concept of  marking  is what allows to calculate the sale price of the company, since it allows to know what prices the entrepreneur can charge.

To calculate the company’s markup index   , it is necessary to have knowledge of the fixed and variable expenses, and the level of profit that you want to achieve. These values ​​can be arranged in an Excel spreadsheet for easy calculation.

Markup  results  in a value that can be used as a percentage multiplier or divider, to be applied to the acquisition or production costs of a well. For this, the formula can be used:

MARKUP = 1 / (1 – (DF% + DV% + ML%))

  • DF: proportion in fixed expenses, such as employee salaries, rent, loan payments, etc.
  • DV: percentage of variable expenses, which are costs that vary as more quantity is produced, as is the case with some taxes;
  • ML: Desired profit margin for the business. The higher, the more profit you will have when you reach the sales level.

This value resulting from the index can be multiplied by the cost of acquiring the goods, providing a service or producing, which are values ​​that do not appear in the calculation of the index.

Markup Calculation Example 

For a company that has a fixed expense ratio of 18%, variable expenses including taxes of 28%, and an expected profit margin of 30%:

MARKUP = 1 / (1 – (0.3 + 0.28 + 0.18)) = 1 / 0.24
MARKUP = 4.10

If this agreement involves the resale of merchandise costing $40.00, your resale price may be $164.00, since 4.10 x $40.00.

If the price is high for the market level, the margin is likely to be reduced, which also reduces the price charged.

How to Calculate Contribution Margin Sales Price

The contribution margin can be used to define the unit sale price, for each product, by relating only the variable costs and expenses to the value.

For the contribution margin, it is only necessary to consider the variable costs,  which are directly linked to the product  , and form the price of the expected revenue from each sale:

Contribution margin = Revenue at price charged – (Variable costs and expenses)

The contribution margin can be calculated in percentage values, indicating the proportion of income by discounting variable costs and expenses:

MC (%) = Contribution margin / Price

The proportions in the contribution and cost margins is what results in the price charged, so the price can be interpreted in several ways, performing the opposite process:

Price = MC (%) + Variable costs and expenses (%)

Contribution margin calculation example

For a product purchased for a unit price of $50.00, with a tax rate of 10%, that is, for an amount of $5.00, plus other variable costs that reach $7.50, we have:

Variable costs and expenses per unit: 50.00 + 5.00 + 7.50 = $62.50

Therefore, if the price charged is $110.00, the contribution margin of the product has the value of:

Contribution margin: 110.00 – 62.50 = $47.50

For this price, a margin of 43.18% is calculated, that is, the percentage of income over variable costs and expenses in this scenario. If the price is higher, the margin changes and its percentage also increases.

To define a fixed proportion of the contribution margin, it is necessary to consider the remaining proportion that makes up the costs. For example, if the margin should be 60%, the costs should be 40%, which together make up the sales price.

Price (income)$156.25100%
Variable costs and expenses.$62.5040%
Contribution margin$93.7560%

The sale price is responsible for the total proportion, since they include the costs and the margin expected by the dealer.

Since the costs are $62.50 per product, at a ratio set at 40%, the calculated margin with the remaining 60% should be $93.75, which can be found in a simple “rule of three”.

Set the price for market research

If a company is involved in a market with several competitors, it is necessary to analyze the prices they charge.

In the event that the market projects a price well below what can be charged, the profit margin will be reduced in terms of what would be expected, or even below costs, making the project unfeasible.

For an activity in which costs are reduced, entering a competitive market can be advantageous since it is possible to reduce prices and carry out promotions that attract more customers.

Furthermore, controlling the price levels in the market is essential to start activities and also to keep the business at the most ideal level possible.