Production costs play an important role in maintaining production activities and the growth of a business. In addition, this fee contributes significantly to the overall economic development of the country. Let's learn more about the concept, classification and meaning of this cost with Viindoo in the article below.
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What is the production cost?
Production costs are necessary expenses associated with the production of products in a business. Those costs include Labor costs, raw material costs, and general production costs.
The difference between production costs vs manufacturing cost
Production costs encompass both fixed and variable expenses.
- Fixed costs are those that remain constant, such as building rent, advertising budget, business equipment, and other miscellaneous expenses that are unaffected by moderate changes in business volume.
- Variable costs, on the other hand, fluctuate based on production volume and can include supplies, wages, and other expenses that change accordingly.
Manufacturing companies calculate their overall expenses by determining the cost of production per item, which plays a crucial role in setting the wholesale price. As production rates increase, the company's revenue rises while fixed costs remain unchanged, resulting in a decrease in the per-item manufacturing cost and greater profitability. This lower per-item fixed cost often drives businesses to expand production up to their maximum capacity, enabling them to achieve higher profit margins after factoring in all variable costs.
Manufacturing costs are greatly influenced by variations in production volume, with total expenses rising as production increases. Many businesses are motivated to expand production up to their maximum capacity to achieve a lower fixed cost per item. Although the per-item cost remains relatively stable, additional production always incurs additional manufacturing costs.
These manufacturing costs can be classified into three main categories:
- Materials
- Direct labor
- Overhead
All of these expenses are considered direct costs, meaning they directly contribute to the production process, unlike indirect costs such as the salary of the company accountant or their office supplies, which are not included in manufacturing costs.
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Production costs vs Manufacturing cost Examples
The company incurs fixed monthly costs of $800 for the building and $100 for equipment maintenance. These expenses remain constant, regardless of the production level. Consequently, if the business manufactures a greater number of products, the per-item costs decrease.
In this instance, the total production costs comprise $900 per month as fixed expenses, along with $10 as variable expenses for each product produced. To manufacture each product, the business needs to procure supplies at a cost of $10 per unit. The selling price of each product is $100. Deducting the manufacturing cost of $10, the business generates a profit of $90 per product.
To break even, the business must manufacture a minimum of 10 products every month. To achieve profitability, the business needs to exceed the production of 10 products.
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Types of production costs
Currently, people divide production costs based on many different criteria. Some common classifications among businesses are presented below.
Classification by nature
Production costs when classified based on nature help enterprises understand the proportion and structure of each type of cost to be spent in a certain period of time.
These costs include:
- Assignment costs;
- Cost of purchasing raw materials;
- Fixed asset depreciation expense;
- Expenses for outsourcing and other expenses;
According to economic characteristics, there are five types of costs in production.
Classification by uses and purposes
If classified according to uses and purposes, production costs include:
- Fees used in materials;
- Cost of hiring and paying employees;
- General production costs such as depreciation of fixed assets, materials;
- Outsourcing costs;
- Cost of production facilities and other costs.
This classification makes tasks such as managing and calculating production costs according to norms easier to perform. In addition, businesses proactively know the status of product planning. This is the basis for production capacity planning and cost planning in the next production period.
This classification helps businesses easily manage costs and calculate product costs.
Classification by behavior
Sorting by relationship with workload and products during the period help managers find the breakeven point. This is also the basis for businesses to make policies and decisions such as changing product prices to increase business efficiency. The costs under this classification include:
- Variable costs
- Fixed costs
Variable costs and fixed costs
Classification by production processes
Classification by production and manufacturing processes divides costs into two categories:
- Base costs;
- General expenses.
The division into these two costs helps businesses determine the correct direction as well as provide measures to maximize cost savings for each type. The methods given will determine the profitability of the business.
Sorting by production and manufacturing process, there are two types of cost: basic and general
Classification by traceability
Objects of this type of classification include two types:
- Direct costs;
- Indirect costs.
This classification helps businesses have a reasonable cost allocation policy for objects through determining the group accounting method.
Direct and indirect costs
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Meaning of production costs
A quality product at a reasonable price is the result of effective production management in general and production cost in particular. Therefore, this fee is not only meaningful to business activities of enterprises but also contributes significantly to the development of the national economy.
- For enterprises: Managers have a correct view of manufacturing production planning and production scheduling through costs. Once they have the right assessment, they can find the optimal measures to improve product quality and save production costs.
- For the country: Government agencies have an overall and objective view of the development of the country's economy by observing and evaluating business activities on the market. Based on that, economic agencies, the Party and the State make the right policies and guidelines to promote the development of the economy.
Production costs are not only meaningful to the development of enterprises but also the country.
FAQs
What is the difference between production cost and manufacturing cost?
Manufacturing cost refers specifically to the expenses incurred during the production process, such as raw materials, labor, and overhead costs. Production cost, on the other hand, encompasses the broader scope of expenses throughout the entire production and supply chain, including manufacturing costs as well as marketing, distribution, administrative overhead, and taxes.
What is the cost of production in economics?
In economics, the cost of production refers to the expenses incurred by a firm to produce goods or services. It includes costs associated with inputs such as labor, raw materials, equipment, and overhead expenses. The concept of cost of production is important for analyzing profitability, pricing decisions, and understanding the efficiency of production processes in an economy.
How do you calculate production cost?
The total product cost formula is Total Product Cost = Cost of Raw Materials + Cost of Direct Labor + Cost of Overhead.
The above article Viindoo has provided businesses with the most comprehensive view of production costs. Understanding the fees of business operations is a way for managers to manage and grow the business well.
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