In most cases, cost and price are used interchangeably. However, the two words have different meanings when it comes to financial statements and accounting. When making investment decisions or conducting financial analysis, it is vital to understand the key differences between cost and price. You should also know how the two affect a company’s financial position.
This article discusses the key differences between cost and price and the factors affecting them.
What is Cost?
Cost refers to the expense incurred to create a product or service offered by a company. For example, the cost of creating service might include raw materials used. It is important to note that the amount of money invested in producing a product directly impacts its price and the resulting profit.
To create a balanced financial situation, some companies list the total cost to increase the chances of maximizing profits. They put into consideration the total direct costs incurred during production. These costs might include things like raw materials and direct labour input.
For example, a retail store might add the cost of operating expenses and wages for plant operators. When items are sold through a website, the expenses incurred when creating the site might be included in the total cost.
What is Price?
Price refers to the total amount a customer is willing to pay for a service or product. Profit is the difference between the costs incurred and the price paid. For example, if a customer pays $20 for a product that cost $14 to manufacture and sell, the business earns a $6 profit. The supply and demand of a product determine its fair price.
The two forces are always trying to achieve a balance, whereby the quantity of a produced product matches its market demand. This concept allows for constant price adjustments as the market fluctuates. From this perspective, the cost implies the amount of money involved in the production, marketing, and distribution. Besides, the term can also refer to the total amount of money required to maintain a product or service.
Key Differences Between Cost and Price
Two crucial aspects run every business: the cost it is incurring to remain afloat and the amount of money it charges from customers to recover the cost. This section discusses the key differences between cost and price. The two form major parameters of any business and helps it gain profits in the long run.
- Price refers to the amount of money paid for the products or services acquired. Cost, on the other hand, is the expenses incurred when producing the product. The same price applies to all customers or consumers. Similarly, the cost is the same for all customers. The cost of a product, however, differs specifically for the company that creates it.
- At the business level, the price comes after the determination of all costs. This does not apply to costs because they are determined first before anything else.
- The price of a product is estimated through policy. Contrary to that, the cost is accessed on actual expenditure incurred during production. Cost should be lower than the price to ensure that the company is making profits.
- The fluctuating nature of the market can affect both the cost and price of a product. The difference is that, for its cost, the changes are outside the control of a company, and it cannot do anything to regulate it. It is a different case for the price because a company can decide to reduce or increase its products’ price.
- Both terms refer to the element of money. For the price, the use of money is gaining something. On the other hand, cost refers to the amount of money given out to facilitate the production process. For example, it can be bills, materials, wages, labour, among others.
- The determination of price is done with the view of consumers. On the other hand, determining a product’s cost is done from the company’s view.
- When you buy a new phone, the amount of money you pay for it is its price. Whereas, the amount of money the phone developer invested in manufacturing that phone is its cost. Usually, a product’s price is higher than its cost because the price includes the profit margin.
Factors Affecting Price
Two significant factors affect the price— supply and demand. Supply refers to the number of products or services the market can provide. They include tangible (such as crane, cars and trucks) and intangible services ( such as hairdressing and data entry). In either of these examples, the supply is finite. This means that there is a certain amount of products and services available at a given time.
Demand refers to the market’s desire for a product, whether tangible or intangible. Just like supply, the number of potential customers is finite. Demand might vary depending on several factors, such as affordability, an item’s value or the consumer market.
Factors Affecting Cost
There are two main factors that affect the cost of a product— risk and inflation. The principle of “high-risk high-return” works here too. For products where the investment involves high-level risk, its cost is most likely to be high. In most cases, products that involve a lot of risks and high product cost tend to be more costly. Risk is a factor that directly affects the cost of a product.
Inflation also affects the product cost. In most cases, capital providers invest in a way that maximizes profits. Besides, the availability of raw materials and other production essentials directly affect the cost of a product. The cost might be higher for products that have scarce raw materials. Similarly, products that have readily available raw materials tend to have a low production cost.
Conclusion
The cost and price of a product are vital for business operations. A company will be able to set the right prices for their products with the aim of increasing profitability. Cost and price are two factors with significant importance profits are to be gained.
A company needs to do a detailed analysis of its cost vs price. This will help identify the best way to budget for production and how to increase profit margins.
