Prime Cost, Pricing Strategies, Production, and Budgeting

Posted on Feb 17, 2025 in Economy

Prime Cost and Conversion Cost

Prime Cost: Direct Materials (DM) + Direct Labor (DL). These costs are most convincingly associated with and traceable to a specific product.

Conversion Cost: DL + Overhead (OH). Costs directly or indirectly necessary for transforming raw materials and purchased parts into a saleable, finished product.

Pricing Strategies

Pricing: What the seller believes the buyer will pay for a certain product. It can be fixed or negotiated.

Geographical Pricing

  • Ex-works Pricing: The customer pays for transportation.
  • Delivered Pricing: The price includes the transportation cost.
  • Uniform-Delivered Pricing: The same delivered price is charged regardless of customer location or actual shipping costs.
  • Zone-Delivered Pricing: The seller assigns each customer to a geographic zone and charges the average cost of shipping within that zone.

Skimming Pricing

Skimming pricing involves setting a high price before other competitors enter the market. It’s suitable for:

  • High-quality products.
  • New products in the market.
  • Products with low price elasticity.
  • Products that are difficult to copy, delaying competitor entry.
  • Snob appeal.

(Competitors may want to enter the market due to high profits but are often prevented by technological advantages, legal protection (e.g., patents), or high investment requirements.)

Penetration Pricing

Penetration pricing aims to increase market share and discourage competitors by setting a low initial price. It is effective when:

  • Price elasticity is high (low price leads to high demand).
  • The product is easy to copy.
  • Consumers do not perceive low price as an indicator of low quality.

(Competitors are discouraged from entering the market due to the low profit margins.)

Production Management

Purchasing Cycle

  1. Requisition: Determining the type and number of items needed.
  2. Value Analysis: Finding the lowest-cost way to satisfy the request.
  3. Supplier Selection: Evaluating suppliers based on prices, delivery times, quality, etc.
  4. Order Placement: Issuing a formal purchase order.
  5. Order Monitoring: Scheduling.
  6. Order Delivery: Handling transportation, quality control, and payment.

Production Planning

  • Routing: The movement of a part or workpiece from one operation to the next.
  • Loading: Determining how long it takes to perform a particular operation.
  • Scheduling: Determining when an operation is to be performed.
  • Dispatching: Preparing and issuing work orders.
  • Follow-up: Tracking completed work.
  • Corrective Action: Scheduling overtime, shifting work to other machines, etc.
  • Re-planning: Adapting to changing market conditions, manufacturing methods, labor force, etc.

Product Life Cycle:

  1. Forecasting sales.
  2. Introducing new products.
  3. Managing products.

Branding

A brand name should be:

  • Short
  • Easy to spell
  • Easy to understand
  • Appropriate for the product
  • Emphasizing the product’s major attributes
  • Distinctive
  • Easy to remember
  • Not used by another company

Benefits of Branding:

  • Repeat Sales: Customers who like a branded product are likely to buy it again.
  • New Product Sales: Customers who like a branded product may purchase other products with the same brand name.

Taxation

  • Liable of Tax: The legal entity, organization, or individual pursuing a taxable activity.
  • Subject of Tax: The object or activity that triggers taxability.
  • Base of Tax: The natural or monetary value on which the tax is established.
  • Taxpayer: The entity that actually pays the tax.
  • Direct Taxes: Taxes assessed on individuals or legal entities based on income or other indicators of ability to pay (e.g., corporate income tax, personal income tax).
  • Indirect (or Turnover) Taxes: Taxes imposed on the end user or consumer, separate from the taxable person (e.g., value-added tax).

Master Budget

  • Master Budget: A comprehensive set of all budgetary schedules and pro forma financial statements.
  • Operating Budget: Expressed in both units and dollars.
  • Financial Budget: Aggregates monetary details from the operating budgets. Includes cash budget, capital budget, and pro forma financial statements.

Prepared for a specific period, more static than flexible.

Formula: Sales in Units + Desired Ending Inventory = Total Needed – Beginning Inventory