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How can management accounting inform pricing decisions?

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Pricing is one of the most important and challenging decisions that managers face in any business. How can you set the right price for your products or services to maximize your profits, satisfy your customers, and stay ahead of your competitors? One way to answer this question is to use management accounting, a branch of accounting that focuses on providing information for internal decision making and planning. In this article, you will learn how management accounting can inform pricing decisions by using four key tools: cost-volume-profit analysis, target costing, value-based pricing, and transfer pricing.

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Yohanes Sirait

Financial Planning & Analysis Manager | CA | CMA | FMVA

1 Cost-volume-profit analysis

Cost-volume-profit analysis, or CVP analysis, is a technique that helps you understand how changes in price, volume, fixed costs, and variable costs affect your profit. By using CVP analysis, you can calculate your break-even point, or the level of sales that covers your total costs, and your margin of safety, or the amount of sales that exceeds your break-even point. You can also use CVP analysis to determine the optimal price that maximizes your profit, given your cost structure and demand curve. CVP analysis can help you evaluate the impact of different pricing strategies, such as discounts, bundling, or price discrimination, on your profitability and sales volume.

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Kareem Hassan

Financial Controller | Chief Accountant | Senior Accountant |
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Also, the CVP analysis is building on assumptions like:- 1- Define costs as fixed and variable cost. 2- the relation between revenue and costs (for multiple products) will remain the same through contribution margin. PLUS You can calculate the break-even point which is Fixed Costs / Contribution Margin per unit the result of the formula will give you several units you need to break even ALSO YOU CAN CALCULATE IT based on the Contribution Margin per unit (selling price per unit - variable costs per unit) OR based on Contribution Margin Ratio ( Revenue - Variable costs)/ Revenue if you want to calculate it with target profit and safety margin you can add the value of those numbers with fixed costs in the break-even formula.

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Yohanes Sirait

Financial Planning & Analysis Manager | CA | CMA | FMVA
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Agree about that, CVP analysis help us to find the sweet spot between the cost and volume to maximize the profit, one things that need to be considered when we do the analysis is: - What is our cost, the nature of the cost (how the expense incur, is it variable or fixed, etc), and the methodology that we use to attributing the cost to our product - Understanding the installed capacity and the optimal capacity - Pricing applied

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2 Target costing

Target costing is a method that helps you set the price of your product or service based on the value that customers perceive and are willing to pay. By using target costing, you start with the desired selling price and then subtract your desired profit margin to get the target cost. Then, you compare the target cost with the actual cost and identify ways to reduce the cost gap through design improvements, process innovations, or supplier negotiations. Target costing can help you align your pricing with your customers' expectations and preferences, and achieve cost efficiency and quality at the same time.

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Yohanes Sirait

Financial Planning & Analysis Manager | CA | CMA | FMVA
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Target costing is one of the easiest approach that we can use to determine our price, where if we compare with ABC (activity based costing), this method spend lesser time and company doesn't need to spend much money. But of course the it also has several weakness, where in my opinion the biggest disadvantage is it will shift the orientation of the company from how to produce a distinctive product to how to reduce the cost so we could get the desired margin, at the desired price.

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3 Value-based pricing

Value-based pricing is a strategy that helps you set the price of your product or service based on the value that you create for your customers, rather than the cost that you incur or the market price that you face. By using value-based pricing, you estimate the benefits that your product or service provides to your customers, such as increased revenue, reduced costs, improved satisfaction, or enhanced reputation. Then, you capture a portion of that value as your price, while leaving some value for your customers as an incentive to buy. Value-based pricing can help you differentiate your product or service from your competitors, increase your customer loyalty and retention, and boost your profit margin.

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4 Transfer pricing

Transfer pricing is a concept that helps you set the price of transactions between different divisions or subsidiaries within the same organization. By using transfer pricing, you can allocate the costs and revenues of intercompany transactions to reflect the economic value of each unit's contribution to the overall performance. Transfer pricing can help you coordinate your internal activities, motivate your managers, evaluate your divisional performance, and optimize your tax position. However, transfer pricing can also create conflicts and distortions if the prices are not set in a fair and consistent manner.

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Yohanes Sirait

Financial Planning & Analysis Manager | CA | CMA | FMVA
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The key point for transfer pricing is having a good control framework. Since mostly this method was use to proven that there is no profit shifting for cross-border transactions and to ensure that the intra group transactions was delivered following arms length principle, decision maker should design a control framework that guide subsidiaries to properly documenting their activities (since a good documentations are critical for proving the fairness of the transfer pricing) and maximize the interest of whole group.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can management accounting inform pricing decisions?

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1 Cost-volume-profit analysis

2 Target costing

3 Value-based pricing

4 Transfer pricing

5 Here’s what else to consider

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