Production Costs
Production costs encompass all the indirect and direct costs companies face when producing the product or offering services. Production costs may comprise a range of costs like labor, raw materials, manufacturing consumables, and general overhead.
Understanding Production Costs
Production costs are often referred to as product costs incurred by a company when it produces products or offers services. They include a range of costs. For instance, manufacturers incur production costs for the materials and labor required to make the product. The service industry incurs production costs related to the work required to execute the service and the cost of the materials used in the delivery of the service.
Taxes imposed through the federal government or the royalties from companies involved in the extraction of natural resources are also considered production costs. When a product is completed and is recorded by the company, it can record its value by registering it as an asset on its accounts until it is sold. Recording a completed product as an asset is a way to satisfy the company's reporting requirements and inform shareholders.
Manufacturing Costs
Manufacturing costs are the expenses that are incurred in the process of making an item. These expenses include the cost of direct materials directly labor, direct labor, along with manufacturing costs. These costs are usually reported within the financial statements as line items. The entity can incur these costs in the manufacturing process.
Direct material is the material employed in the production of the product. Direct labor is the portion of the cost for labor in the production process assigned to an individual piece of the production. Costs for manufacturing overheads are assigned to production units according to a range of allocation methods that include direct hourly labor or machine time incurred.
Best Practices to Manage Production Costs
The main goal of any company is to cut production costs without sacrificing its quality or the service they provide. There are a variety of methods to achieve this, most of which involve looking back at prior numbers and evaluating each step of the manufacturing process.
Track the Production Numbers
Implementing the formulas for the cost of production in the above sections will provide a detailed breakdown of the money being used to make your service or product ready for sale to customers. It's recommended to calculate the production cost at regular intervals (i.e., per quarter, per month, or month, as well as each season) to spot any fluctuations in your total expenses and evaluate the impact on sales and profits for your business.
Lower the Cost of Supplies and Materials
Raw materials and components comprise a large portion of the production cost. Most of the time, suppliers will bargain favorable terms to keep an existing client. Find out about discounts available for contracts with longer or larger orders, as well as cash payments. It is also beneficial to obtain quotes from different suppliers or explore alternative materials that don't sacrifice quality.
Improve the Efficiency of Production
Examine the steps and resources that are used to make your product. Talk with your production team and find ways to simplify the process. Look for tasks that seem too time-consuming or unneeded and devise methods to enhance or modify workflows. If necessary, Conduct A/B tests to determine improvement parameters like production results or the number of resources saved and then reevaluate any changes periodically.
Eliminate All Unnecessary Costs
Are there any costs you can reduce that aren't a major difference in the end item or the service? For example, many companies invest a lot of money in packaging, which results in larger packages, a greater cost of shipping, and inefficiency. In a D.S. Smith packaging survey conducted in August of 2020, the survey revealed that nine out of ten respondents claimed to receive boxes that were stuffed with a waste box filled wasted space 73% of those reported receiving a box that was double the size, or more than what was needed. Other areas where you can reap opportunities for savings include consolidating deliveries, maximizing the amount of inventory available, and scheduling regular maintenance of equipment to avoid downtime and malfunctions.
Example
A small-scale business that produces widgets could have fixed monthly expenses of $800 for its buildings and $100 for equipment maintenance. The costs remain identical regardless of the amount of production; therefore, the cost per item is reduced when the company produces more widgets.
In this instance, the total costs for production include $900 in fixed costs and the variable expense of $10 for each widget made. The company must purchase the necessary supplies at $10 per widget to make every single widget. Each widget is sold for $100. After subtracting the cost of manufacturing which is $10 each, each product earns an investment of $90 for the company. To make it profitable, the company must make ten widgets each month. It should produce greater than ten widgets to be profitable.
