Reviewed by Oct 05, 2020| Updated on
It is essential for a business owner to know the cost of production. The process of figuring out the cost of production plays a vital role in building and managing a profitable business. When a business owner knows the cost involved in each step of production, the owner can optimise the processes involved in production, schedule delivery realistically, and plan other business activities to run the business much more efficiently.
The total price paid for the resources used to manufacture a product or create a service, such as raw materials, labour, and others, is called the production cost. The product/service created is to be sold to consumers.
In the case of mining companies, the royalties owed are also treated as part of the production cost. Even the tax liabilities belong to this category.
Accountants from the business management side keep track of the production processes and the costs involved to price the goods and services properly so that they can achieve an appropriate margin.
Consider a fruit juice manufacturing company. The company notes the prices of fruits, sugar, preservatives, packaging, labour, and distribution required to produce fruit juice. If there is an increase in the price of one of these factors, the juice manufacturer will have to increase the price of fruit juice to maintain the margin.
If an expense is to be labelled as production cost, it must be directly involved with generating revenue for the company. While product companies consider raw materials and labour involved for calculating production cost, service companies consider the labour involved and the cost of delivering the service for calculating the production cost.
Also, production costs comprise direct and indirect costs. The former is the cost involved to buy raw materials and labour cost; the latter involves other overheads, such as rent, utility expenses, and administrative sales. The production cost per unit can be determined by summing up the total raw material costs, labour costs, and manufacturing overhead, and dividing the result by the number of units manufactured.