What does Lower Price Limit Mean?

The long-term and short-term lower price limit play an important role for you as an entrepreneur. Basically, every type of lower price limit should help ensure that you do not suffer any losses with your company . A lower price limit is a very important tool for you to be able to maintain your company in the long term. In order to explain the short-term and long-term lower price limit in a simple way, just keep reading this article.

What is a lower price limit?

The term lower price limit is used to describe the sales value, because as an entrepreneur you must at least achieve so that you do not incur losses. To determine the lower price limit, you have to work with the contribution margin calculation as a basis . With this lower price limit, a distinction is always made between different types of lower price limit in connection with cost unit accounting. There are the following lower price limits:

  • the short-term lower price limit
  • the long-term lower price limit
  • the liquidity-oriented lower price limit

Each of these types of lower price limit has its very special and specific characteristics.

Liquidity-oriented lower price limit

With the liquidity-oriented lower price limit , the focus is on the company’s liquidity . For you as an entrepreneur, one of the most important goals must always be to ensure your liquidity. If you only consider the short-term or only the long-term lower price limit, however, the eye on liquidity falls by the wayside. There are several circumstances in which you can run into liquidity issues. For example, if you cannot sell all of the products manufactured in the same time window in a given period. However, it is also possible that a customer of yours is experiencing liquidity difficulties and that he has the agreed payment termcan not adhere to. A feature of the liquidity-oriented lower price limit is therefore that you include all variable costs as well as your income and the short-term expenditure-effective fixed costs in your calculation in your cost and performance calculation.

Difference between the short-term and long-term lower price limit

According to HEALTHKNOWING.COM, there are certain peculiarities between the terminology of short-term and long-term lower price limit, which you must absolutely consider. In the following overview you can see these special features and also clearly what short-term and long-term lower price limit should fulfill in their function.

Short-term lower price limit Long-term lower price limit
  • The short-term lower price limit is also called KPU or absolute lower price limit .
  • It corresponds to the variable costs that your company incurs, for example through production.
  • With the short-term lower price limit, you have to consider that no fixed costs are taken into account here. For you as an entrepreneur, this means that you will incur losses when selling products if your price is equal to your variable costs.
  • With a short-term price limit, you can only sell for a short time the products that are priced at variable costs.
  • This approach only makes sense if you can also get market share through this KPU .
  • If you make a loss through the selling price at variable costs, this corresponds to the loss you would incur if you did not manufacture any products and do not sell any products.
  • The long-term lower price limit is abbreviated to LPU.
  • It represents the minimum of the average unit costs and corresponds to the prime costs.
  • Both variable and fixed costs are used in the calculation for the long-term lower price limit .
  • With this long-term lower price limit, you will not make a loss with your company, but neither will you make a profit. That’s because your costs are being met exactly .
  • If you want to calculate the long-term lower price limit, you have to make sure that your fixed costs are always consistently high. In concrete terms, this means that the moment the number of pieces decreases, the total cost per piece increases.

Formula for calculating the short-term lower price limit

In order to be able to calculate the short-term lower price limit, you need the average of the variable unit costs . The decisive factor, however, is first of all whether it is a linear cost function or whether a polynomial is contained in the cost function . In this case, you will be charged differently, but the variable costs per unit still correspond to the short-term lower price limit.

The formula for the short-term floor price with a linear function is quite simple. All you have to do is use the following formula:

Formula for the short-term lower price limit:

Sum of the variable costs / number of pieces

Examples

For the next quarter you are calculating with sales and production of 2,000 pieces. You have to consider the following costs:

  • Material costs (variable): 180,000 euros
  • Labor costs (variable): 120,000 euros
  • Distribution costs (variable): 60,000 euros
  • Salary costs (fixed): 70,000 euros
  • Administrative costs (fixed): 130,000 euros

Application of the formula:

180,000 + 120,000 + 60,000) / 2,000 = 180 euros per piece

Formula for calculating the long-term lower price limit

You can calculate the long-term lower price limit in two different ways. On the one hand, with the first method, you can derive the average cost function , then set it to zero and build the resulting value back into your unit cost function. You can also consider your prime costs when calculating. You need the following formula for the calculation:

Unit costs + fixed costs / number of goods produced = LPU

When calculating the quantity in the operating optimum, you need the following formula:

Then insert K (x) / x = 0 in the unit cost function → LPU

But you can also use a very simple formula:

LPU = cost

Examples

Let’s stick to the requirements mentioned in the example above. You are planning a quarterly sales of 2,000 pieces and you want to produce the same amount.

  • Material costs (variable): 180,000 euros
  • Labor costs (variable): 120,000 euros
  • Distribution costs (variable): 60,000 euros
  • Salary costs (fixed): 70,000 euros
  • Administrative costs (fixed): 130,000 euros

Application of the formula:

(180,000 + 120,000 + 60,000 + 70,000 + 130,000) / 2000 = 280 euros per piece

Conclusion

The basis for determining the lower price limit is the contribution margin calculation . With regard to cost and performance accounting, a distinction is made between three types of lower price limit . There is the short-term lower price limit, the long-term lower price limit and the liquidity-oriented lower price limit. For all three types, certain peculiarities also apply in their calculation and the formulas for their calculation.

Lower Price Limit