The words cost and price get used interchangeably, although the two mean completely different things when it comes to accounting. Understanding the key differences is essential when companies undergo a financial analysis or hope to make large financial decisions.
Simply put, the difference between the terms comes down to the amounts of expenses incurred by the business on items such as materials, labor, sales, utilities, and other business-related expenses. In this article, we’ll take a closer look at the difference between cost and price, providing examples for clarification.
What is cost?
The cost refers to the total paid by the company to produce or sell its product or item to the public. It is all the costs involved throughout the entirety of the process, from manufacturing to stocking shelves. A good way to think of cost from the producer’s perspective—the expenses the business sees.
Most of the costs will belong to various categories on financial statements, such as the cost of advertising, the cost of goods sold, and the cost of labor. These statements disclose the money involved in the development of a particular product or service.
Costs can further be divided into the following two different categories:
- Fixed cost—costs that do not change no matter the amount of product produced by the company. A good example of fixed cost are expenses such as warehouse rent or insurance.
- Variable cost—these costs change depending on the amount of product produced. An example of variable cost includes raw materials, labor, and shipping. In other words, variable cost is a business expense that isn’t predictable.
Example of cost
An example of a cost is the amount spent developing an item for sale within a store. Let’s say the company develops toys for children—there are various raw materials the company needs to produce the item. In this example, one of the costs the company incurs is purchasing materials such as plastic that they will manufacture into a toy product.
What factors affect the cost of an item?
The total amount of funds the company spends makes up the product or service cost. This falls into the following various categories:
- Product development
- Market demand
What is price?
The price included is the total amount of money the business charges in exchange for its goods or services, also known as the transaction price. Although a company can set the price of goods and services to any amount they choose, the overall number is influenced by many factors since it’s a consumer market.
A fair price is not necessarily any number the business wants to set. It’s important to keep in mind the consumer’s perspective when asking them to buy what the company sells.
Example of price
We run across the price of an item any time we make a purchase or hire someone to perform a service. A price is the amount paid, such as $4.99 for a bag of chips or $399 for a window replacement. This is the number the customer sees at the checkout before any taxes get added.
What factors affect the price of an item?
Factors inside and outside of the company will impact the overall price of an item to find the right price. These factors include:
- Supply (market saturation causes a lower price)
- Market demand
- Prices of the competition
- Company market position
- Distribution channels
- Potential customer purchasing power
- Government regulations
Each of these factors works together to set the final price of an item or service. (Check out this article for further information on understanding pricing strategies.)
What’s the key difference between cost vs. price?
The most significant contrast between price and cost is who pays. The cost is something paid for by the company that makes the product or provides the service. So companies are the ones who incur the cost before they can roll things out to the public.
The price is something paid by the customer. Generally speaking, the price the customer is willing to pay will be higher than the cost incurred by the company to ensure the business has revenue and can provide additional products or services.
Price vs. cost example
Let’s walk through a quick example to demonstrate the distinction between cost and price. Assume the company we’re discussing produces furniture. Before the company can start selling its product to consumers, they incur various costs such as purchasing raw materials, labor, equipment, marketing, shipping, etc.
For a better visual, let’s assume the company calculates that after every bill is paid, it takes $300 to make one cabinet. This cost will include making the product and getting it into the hands of the customer.
When the customer purchases the cabinet, they will pay the product’s final price, including all costs incurred by the company that made it, plus overhead. As a result, the consumer will see the final price as $499—which the company decided on when considering certain factors such as costs, competition, supply and demand, and overall market standing.
Frequently asked questions
When a customer can purchase a product at the price it took to make it, that is known as the cost price. This is because they did not pay any more than the company did to make the product. A selling price, or buying price, is the final amount the customer pays for a product. The selling price is going to be higher than the cost price allowing the company to turn a profit and continue making future products.
Both the price and cost analysis are two distinct methods of projecting costs for projects and programs provided by a company. Price analysis is the most popular of the two methods, where the vendor unit price is analyzed. Cost analysis is not as popular because it involves more moving pieces. However, the general idea is to analyze the price and the cost incurred by the company to see if the price quotes are fair.
Price and cost might sound similar to one another; however, in terms of financial statements and analysis, they couldn’t be more different. The difference between cost and price comes down to who pays.
The cost is the total amount of funds a company spends to produce a product or provide a service to a customer. The price is the amount the customer is willing to pay for the product. Many factors determine the amount of cost and price paid by the company and the customer.
Most of the time, the current market and supply and demand heavily influence the amount of funds spent by the company and the customer. To learn how to minimize these costs, take a look at How to Effectively Manage Business Expenses: A Guide for Small Business Owners.
Agata Kaczmarek has held a passion for writing since early childhood. A professional writer for many years, Agata specializes in writing articles and blogs focused on finance as someone who holds a Master’s Degree in Accounting and Finance.
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