How To Calculate a Product's Average Selling Price
Updated February 3, 2023
Businesses rely on revenue to stay in operation and fund long-term growth and development, and the predominant means businesses generate revenue is by selling their products and services. A successful selling price is important for businesses and organizations to continue generating revenue as it's necessary for covering the cost of goods sold and providing a profit.
In this article, we will explore what selling price is, how to calculate the selling price using a formula and examples of how you can use the formula for different applications.
What is selling price?
The selling price is the amount customers pay to purchase a product or service and includes the value of an offering plus a value that covers the costs of selling the offering, or the cost of goods sold. The selling price is important for establishing the revenue a business needs to earn in order to reach a set profit margin. Additionally, businesses and organizations typically evaluate various factors when calculating suitable selling prices and may ask questions such as:
What price are customers willing to pay for a product or service?
What is an acceptable price that supports sales and revenue goals?
What is a suitable price to compete in the market?
The methods businesses and organizations use to evaluate questions like these and calculate selling prices can vary depending on the type of operations and overall goals. However, there is a simple formula for calculating the average selling price, which provides a valuable starting point for determining the most suitable price points for your products or services:
Selling price = (cost) + (desired profit margin)
In the formula, the revenue is the selling price, the cost represents the cost of goods sold (the expenses you incur to produce or purchase goods to sell) and the desired profit margin is what you hope to earn. The result allows you to get an idea of where you should start your product pricing. Then, you can use this price point in addition to other factors like competitive prices to set the most reasonable selling price for your offering.
How to calculate selling price
Using the formula selling price = (cost) + (desired profit margin), calculate the selling price with the following steps:
1. Find the cost per item
Calculate how much it costs to sell a product or provide a service, such as the per unit of bulk or wholesale products. For instance, assume a small business sells handmade sweatshirts that it purchases from a local artist. If the business purchases 100 sweatshirts to sell in its shop and pays a total of $1500 for the 100 sweatshirts, the cost per item is $15.
2. Determine your desired gross profit margin
Figure out what your desired profit margin is. This represents a percentage of the total cost price of the items you sell or the services you provide and is the profit you hope to earn. Since your desired profit margin is a percentage of the cost, multiply your costs by this percent.
Using the previous example, after the small business's bookkeeper calculates its costs for selling goods, they must set a profit margin that covers this cost and provides a sustainable profit. In this case, the bookkeeper determines the ideal profit margin is 35%. This value is a percentage of the business's costs of $15 per sweatshirt, so the bookkeeper multiplies (0.35 x $15) to get a desired profit of $5.25 per sweatshirt the business sells.
3. Plug these values into the formula
Put in the cost value and your desired profit margin into the formula to find the selling price. With the previous values, calculate the selling price like this:
Selling price = (cost) + (desired profit margin) = ($15) + ($5.25) = $20.25
The small business determines that a selling price of $20.25 per sweatshirt is an ideal price point for their products. This value covers the costs of purchasing items for resale and provides the business with a sustainable profit.
4. Interpret and apply the result
When you find your selling price using the formula, you can use this value to evaluate your ideal selling price more in-depth. For instance, in the case of the small business example, it might use the selling price of $20.25 as a foundation when performing further analysis on competing businesses and the overall market.
This means the business looks at the prices of other similar establishments and evaluates whether its selling price of $20.25 can compete in the market. Then, the business can either increase or decrease this price point based on its evaluation.
Related: How To Calculate Profit with Example
Examples of calculating selling price
The formula to calculate selling price is useful for a variety of sales pricing, including for pricing services like subscriptions and for digital products. The following examples show how to calculate the selling price for several applications:
Example 1: Calculating selling price for a subscription service
A small online magazine brand offers monthly subscription services to its readers. The brand's accountant is responsible for providing financial insight and overseeing the management of the brand's financial records, so they collaborate with brand managers and directors to find the most suitable selling price for the brand's subscription services.
The accountant calculates the selling price to find the ideal starting point for the magazine's yearly subscription by first finding the total cost of providing the digital magazine. The accountant calculates the following costs of providing subscription services:
Magazine content costs $50,000 monthly to produce.
Marketing expenses amount to $15,000 monthly.
Internet expenses cost the magazine brand $100 per month.
The accountant finds the brand's total costs and multiplies this value by the brand's desired profit margin of 40% to get a total desired profit of $26,040 per month. Using the formula, the accountant calculates the selling price:
Selling price = (cost) + (profit margin) = ($65,100) + ($26,040) = $91,6140. This selling price represents how much the magazine brand must charge in total for monthly subscriptions. The accountant must then divide this number by how many readers the magazine currently has to get an idea of where to price a monthly subscription fee. If the magazine currently has 15,000 readers, this means the monthly fee is ($91,140) / (15,000) = $6.07.
At this point, the accountant can advise the magazine brand to set the selling price of a monthly subscription to $6.07 exactly, or evaluate additional factors that can affect the success of this value. For instance, if competing magazine brands are setting monthly subscription fees at $7 per month, the accountant may suggest increasing the selling price to compete with other similar brands.
Related: What Are Examples of Revenue?
Example 2: Calculating selling price for a software product
A software development company introduces a new software product for business management. The company's marketing team has already performed market research and a competitive analysis to determine what kind of profit margin to set and where the product's price should start. In addition to market research and competitive analysis, the company's financial planner calculates the selling price for additional insight into how the company should price its new product.
The financial planner first determines the cost of producing the software, including payroll for the developers who work on the company's projects and the technology the company relies on. Assuming these costs amount to $350 per software product and the company has a desired profit margin of 35%, the financial planner determines that the company must generate at least $122.50 per product in revenue to cover these costs and provide a profit. The financial advisor calculates the ideal selling price using the formula:
Selling price = (cost) + (profit margin) = ($350) + ($122.50) = $472.50. This means that the ideal selling price of the software product is $472.50.
Example 3: Calculating selling price for a clothing product
A medium-sized retailer purchases seasonal apparel items for resale, including women's swimsuits. The company wants to determine the best possible selling price for its latest one-piece style. Assume each swimsuit has a cost price of $25 per item and the company has a desired profit margin of 50%. The company calculates the selling price like this:
Selling price = (cost) + (profit margin) = ($25) + (.5 x $25) = ($25) + ($12.50) = $37.50.
The retail company must set the selling price of its women's one-piece swimsuits at $37.50 to generate its desired revenue and cover the cost-per-item expenses it incurs to supply its products.
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