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 |
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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.
