What are Production Costs

What are Production Costs.

To start talking about costs it is important to know what a cost is.

A cost is everything that will generate an income, that is, it will represent an investment, whether present or future.

A cost is not synonymous of spending as it is sometimes believed, thus spending is something that we are not going to recover, spending is a concept that decreases our profit or margin and can even generate losses.

Generally in an industry the raw material has to be processed and transformed into new products, that is, the manufacturer does not sell the item identical to how it is purchased, it has to be transformed, and as a result of the transformation the production cost is obtained, which it is just the purchase price plus additional manufacturing costs.

3 elements make up the production cost:

  1. Raw materials or direct materials are those concepts that are part of the product, such as the sole that makes up a shoe and that are necessary for its elaboration.
  2. Containers and packaging are those that do not constitute part of the product for its operation such as bags and boxes that are used to present the packaging.
  3. Labor is divided into direct and indirect labor:
    • The direct labor force is the one that actively participates in the elaboration of the product, directly manipulates the product and the manipulation time can be measured.
    • The indirect workforce is made up of supervisors, managers, secretaries, assistants, administrators, maintenance personnel

 

Other manufacturing expenses can be utilities, office supplies, fuel, rentals, taxes …

The unit production cost is the value of a particular item.

Selling expenses are those that are used to drive the company’s sales and are made up of advertising, advertising, salesmen’s salaries and commissions, administrative expenses …

These expenses are made up for the administration of the company such as the salaries of the administrative staff, rental expenses, electricity, telephone, depreciations …

The financial expenses are originated through the external financing needs that the company requires or the use payment methods that may carry financial costs associated with the service (example paypal). The greater the need for external financing, more financial costs.

 

There are companies that decide to calculate the production cost including the reasonably attributable direct and indirect costs of production, other companies only use direct costs, but there are other companies that allocate absolutely all the indirect costs of the company among the products manufactured through of full costing system.

The value obtained from the production will be inventoried in the warehouse until its sale, the valuation method to be used can be the standard cost, the average cost, FIFO or LIFO …

Once the product is sold to a customer, the production cost becomes what is called cost of sales, and this is what allows us to calculate the profit or gross margin of the sale.

If you need a budget or forecast Cost calculation system working with standard costs for planification and decision making do not hesitate to contact me.

 

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