How to set a price that actually covers your costs
Pricing has two honest starting points. Cost-plus begins with what the thing costs you and adds a target margin — easy to calculate, easy to defend, and entirely indifferent to what the buyer thinks it is worth. Value-based begins with the outcome the customer receives and charges a fraction of it. Most businesses need both: cost-plus sets the floor below which you lose money, and value-based decides how far above that floor you can stand.
The floor is where things usually go wrong. Direct cost is only part of what a sale costs you — rent, software, insurance and salaries all have to come out of the same revenue. A price that covers direct cost plus a comfortable-looking markup can still lose money on every single unit once overhead is allocated, and extra volume makes that worse rather than better.
Discounts deserve the same arithmetic before they are offered rather than after. A price cut comes straight off profit and does nothing to cost, so the volume increase needed to end up with the same total profit is always much larger than the discount itself. Working that number out first turns a discount from a reflex into a decision.
Worked example
A product with a direct cost of 600 per unit, 2,00,000 of overhead a month, and a realistic volume of 500 units a month.
| Input | Value |
|---|
| Direct cost per unit | 600 |
| Monthly overhead | 2,00,000 |
| Expected volume | 500 units |
| Overhead per unit | 400 |
| Fully loaded cost | 1,000 |
| Price | 1,500 |
| Margin at that price | 33.33% |
| Contribution per unit | 900 |
Cost-plus applied to the direct cost alone — 600 plus a healthy-sounding 25% markup — gives 750, which is 250 below what each unit actually costs. Selling more only deepens the hole. The discount arithmetic is just as unforgiving: cutting the 1,500 price by 10% to 1,350 drops contribution from 900 to 750, so you need 20% more volume just to end up where you started. A 20% cut needs 50% more volume.
How to use this calculator
- Total every fixed monthly cost and divide by a realistic monthly volume to get overhead per unit.
- Add that to direct cost per unit — this fully loaded figure, not the direct cost, is your price floor.
- Enter a target margin and read the price it requires, remembering that margin and markup are different targets.
- Check that price against what the market and your competitors actually charge before committing to it.
- Before offering any discount, calculate the volume increase needed to hold profit steady.
Frequently asked questions
Should I use cost-plus or value-based pricing?
Use cost-plus to find the minimum you can charge, and value-based to decide what you will charge. Cost-plus alone caps your price at your own inefficiency and ignores the buyer entirely. Value-based alone risks pricing below cost on work that turned out to be expensive to deliver.
How do I allocate overhead to a single product?
The simplest method divides total overhead by total expected units. If products differ a lot in the resources they consume, allocate by a driver that tracks the effort instead — hours worked, machine time, orders processed. Any consistent method beats ignoring overhead, which is the only genuinely wrong answer.
Is it better to raise prices or cut costs?
A price rise usually wins, because the entire increase drops to profit while a cost cut is often partly offset elsewhere. On a product with a 33% margin, a 5% price rise adds roughly 15% to gross profit if volume holds. The risk is that volume does not hold, which is why increases are usually tested rather than announced.
Why is discounting so expensive?
Because the discount is taken entirely from contribution. When contribution is 900 on a 1,500 price, a 150 discount removes a sixth of the price but a sixth of the profit too, so you need proportionally far more volume to compensate. The lower your margin, the larger the volume increase a given discount demands.
Should I price below competitors to win business?
Only if your cost base genuinely supports it. Undercutting on price alone invites a response you cannot outlast, and it attracts the customers most likely to leave for the next cheaper option. Competing on delivery time, support or specificity is usually more defensible than competing on price.
How often should prices be reviewed?
At least annually, and immediately whenever input costs move materially. Prices left untouched for years quietly erode as costs rise around them, and the eventual correction has to be large enough to be noticed. Small regular adjustments are easier for customers to absorb than one large one.
This calculator is an educational tool. Results are estimates based on the inputs you provide and do not constitute financial advice. Verify figures with your bank, broker or a qualified advisor before acting on them.