To help you set the selling price of your products accurately, it’s important to understand the production costs first. By grasping this concept, you can stay competitive in the market and maximize your profits. In this article, we will discuss what exactly goes into the production cost concept. Let’s get started!
What is Production Cost?
According to the definition by Bastian Bustami and Nurlela (2009:4), production cost includes all costs used in the process of producing goods or services. These costs cover direct raw materials used to make the product, direct labor involved in production, and factory overhead costs such as machine depreciation and factory electricity.
Moreover, production costs are closely related to the products made, as these costs become part of the inventory. In other words, production costs include all expenses needed to create a product, whether directly visible or indirect, which will later affect the product's selling price and company profits.
Types of Production Costs
Production cost is a crucial factor in determining the selling price of a product from a company. There are five types of costs involved in production and price setting:
- Fixed Costs: Costs that don’t change regardless of the production volume. For example, factory rent or insurance fees paid every month.
- Variable Costs: Costs that vary according to production volume. For instance, raw material costs increase when production increases.
- Marginal Costs: Additional costs incurred to produce one more unit of product. This is important when deciding whether to increase or decrease production.
- Average Costs: Total costs divided by the number of units produced. There are two types: average variable cost and average total cost.
- Total Costs: The overall total production costs spent within a certain period.
These five main components of production costs play a very important role in decision-making and financial management. In the next section, we will explore each component more deeply to understand their role in pricing products.
Read also: Production BEP Formula: A Simple Calculation Tool Every Business Owner Should Know
Components of Production Cost
Production costs in any company generally consist of three main components:
1. Raw Material Costs: These are expenses for acquiring raw materials or materials that will be processed into finished products. It includes all costs related to purchasing or processing these materials, such as purchase price, shipping, and storage costs.
2. Human Resources Costs: These include all expenses related to direct labor involved in production. This covers salaries and wages of factory workers or employees directly engaged in making goods or services.
3. Factory Overhead Costs: Overhead costs are production costs that cannot be directly assigned to a specific product. These include factory operational costs like electricity, machine maintenance, factory rent, and administrative expenses related to production.
These three components are integral parts of production costs in any company. By understanding and managing them efficiently, companies can optimize production processes and increase profitability.
How to Calculate Production Costs
To calculate production costs, we need to consider several cost components mentioned earlier. Here are the steps to calculate each component:
1. Raw Materials:
First, calculate raw material costs as an item on the income statement during the accounting period. Use this formula:
Raw material cost = Beginning inventory + Raw material purchases - Ending inventory
2. Labor Costs:
To determine labor costs, account for the hourly rate plus social security, health insurance, bonuses, pension, and others. The steps are:
- Calculate gross wages: annual working hours x gross hourly wage.
- Calculate actual working hours: annual working hours - hours not worked.
- Add all other expenses like additional salaries, bonuses, allowances, and payroll taxes.
3. Overhead Costs:
Overhead costs include all indirect business expenses. We need to review budgets and costs required to produce goods or services for profit. The formula is:
Overhead cost = electricity cost + wages + supplies + insurance + cleaning costs
However, each company may have different overhead expense lists.
After determining raw material, labor, and overhead costs, calculate total production cost with this formula:
Production cost = raw material cost + labor cost + overhead cost
Example of Production Cost Calculation:
- Here is an example:
Raw material cost: IDR 9,500,000 - Labor cost: IDR 6,200,000
- Overhead cost: IDR 8,700,000
- So, total production cost is IDR 24,400,000.
Additionally, you can calculate the production cost per product unit using this formula:
Cost per unit = (electricity + rent + raw material + labor costs) / quantity of products
By understanding and calculating production costs correctly, a company can manage its finances more effectively and set product prices that suit market needs and profitability goals.
After discussing production costs and examples, it can feel overwhelming to calculate everything manually. It’s complicated and time-consuming, right? But relax, now there’s a solution: just use the Opaper POS Application! This app has awesome financial reporting features that automatically generate financial reports, including production cost calculations. So, no more manual hassle. Just a few clicks in the app, and everything becomes easier!
Not only that, with the Opaper POS app, you can be more confident in the accuracy of your production cost calculations. The app is programmed with advanced formulas, minimizing calculation errors. You wouldn’t want your product prices to be off because of careless calculations, right? Using this app can help you avoid that problem.
Besides making calculations easier and more accurate, the Opaper POS app also helps monitor your company’s financial performance. With automatically generated financial reports, you can clearly see how your business finances are doing. So, you can focus more on making better business strategies!
So, don’t hesitate to try the Opaper POS app to manage your business. With its advanced features that automate production cost calculations, you can save time, energy, and definitely boost your business growth.
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