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Activity No. 2 - Calculating your Variable, Fixed and Total Costs and your Break-even Price Costs Variable/Direct Costs - Cost of Goods Sold Your product $ Example $/batch of 400 units 600 800 160 Raw materials (oil, vinegar, spices, salt, etc.) Labor (hours of labor required) Sales Commissions Shipping Charges Others Total Variable/Direct Costs - Cost of Goods Sold 1,660 300 Fixed/Indirect Costs Rent, utilities, interest, taxes, insurance Others Total Fixed/Indirect/Operating costs 300 Total Costs 1,960 Break-even Price = Total Costs/#of Units Produced 1,960/400= 4.90 Example: Gourmet Salad Dressing Gross Margin Method Your Product Cost of Goods Sold/Variable Costs/Unit Desired Gross Margin (GM) Selling Price = Cost of Goods Sold/(1-Desired GM) Example $ 4.19 40% 4,19/(1-0.40) = 6,92 Desired Gross Margin (GM) 30% Selling Price 4.197(1-0.3) = 5,93 Desired Gross Margin (GM) 50% Selling Price 4,19/(1-0.5) = 8,30 CONVERSELY Calculating the Gross Margin for a specific Selling Price Gross Margin = (Selling Price - Cost of Goods Sold)/Selling Price)*100 Selling Price 8,00 Gross Margin (8,00 - 4,19)/8,00)*100 = 48% Selling Price 6,00 Gross Margin k(6,00 - 4,1976,00)*100 = 31% 15 ACTIVITY/APPLICATION Activity No. 1 - Examples of Price Changes' Impact on the Firm's Income Assume a direct marketer is selling just five major items from a farm stand. The direct marketer has calculated gross margin for each product using the "cost of goods sold" and has also estimated the approximate sales for each product as a percentage of total sales. The percentage of sales and gross margin for each product are shown below. Contribution to Total Sales and Gross Margin before Price Reduction Item A. % of Total Sales B. Gross Margin C. Total Gross Margin (estimated) (%) (C = AXB) Peaches 25 40 10.0 Mums 10 2.5 Pumpkins 4.5 Sweet Corn 20 20 4.0 All Others 30 30 9.0 Total 100% 30.0% 25 15 30 Now the stage is set for some useful price analysis. Consider an example. If the direct marketer lowered the price on pumpkins as a Halloween promotion to meet a lower price offered by a competitor or to sell out the seasonal stock, the gross margin for this product most likely will fall. However, one might expect that the volume of pumpkins sales might materially increase at the new, lower price. Assume that the price reduction would result in a gross margin of 10% (a drop from 30%) and an increase in sales to 20% of the total (up from 15%). The impact of this price reduction on her/his total sales and profits would be as follows: Contribution to Total Sales and Gross Margin after Price Reduction Item A. % of Total Sales B. Gross Margin C. Total Gross Margin (estimated) (%) (C = AXB) Peaches Mums Pumpkins Sweet Corn All Others Total As illustrated, the direct marketer will experience a drop in total gross margin from % to % or a loss of _%. Assuming that sales for the business averaged $5,000 per week, this would imply a weekly loss of: $5,000 x _%) = $_/week