Calculating production costs is absolutely essential to accurately determine production costs, allowing you, as a business owner, to determine the right business strategy. The reason, of course, is closely tied to profit.
After all, the primary goal of any business is profitability. Therefore, it’s crucial to understand how to build and manage a profitable business. One way to do this is by calculating production costs.
Now, because calculating production costs is quite complex and involves several components, you should read this article to the end. Pay attention!
What is Production Cost?
Quoting the Investopedia page, production costs refer to all costs faced by a business in producing a product or providing a service, whether incurred directly or indirectly.
Production costs themselves can include various expenses, such as labor wages, raw materials, consumable production equipment, and overhead costs.
Why is it important to calculate production costs?
Knowing how much the costs are during the production process will prevent your business from potential losses.
The reason is, you can later use this production cost calculation as a reference in determining the selling price.
For more details, here are the reasons why you need to calculate production costs. Let’s take a look!
- Calculating production costs is an important aspect of preparing financial statements.
- Prevent business owners from experiencing losses due to uncontrolled costs
- Helps companies to evaluate profits and losses, and prevent fraud
- Assisting the procurement department in selecting and establishing cooperation with suppliers
- Evaluate products and improve the quality of raw materials
- Helping companies determine the right selling price
- Creating efficiency in the production process
- Become a source of relevant data for future decision making
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Components in Production Cost Calculation
As mentioned above, production costs are comprised of several components. The following are the main costs you need to understand before calculating production costs.
1. Direct Material Costs
Direct material costs are the costs of raw materials directly related to the production process to produce a product. These materials will then be processed into a product that has a trade value, and the amount of this cost can be readily identified.
For example, in a bakery, the direct raw materials are flour, eggs, butter, sugar, and other ingredients used directly in the manufacturing process.
2. Direct Labor Costs
Direct labor costs are wages, salaries, allowances, bonuses, and even insurance paid to employees who are directly involved in the production process.
For example, the salary of bakery employees, the salary of employees who work in the production kitchen, and so on.
3. Overhead Costs
Overhead costs or overhead costs are components of production costs that are not directly related to production activities.
However, these costs are still incurred because they support the production process, even if indirectly.
The following are three types of costs included in overhead costs, namely:
- Indirect material costs are all costs of specific materials used in the production process.
However, these costs aren’t directly visible in the resulting product. For example, cooking oil, plastic packaging costs, cleaning fluids for equipment and machinery, and so on.
- Indirect labor costs are labor costs that are not related to the production process at all, but their role is also important.
For example, employees in the quality control department, the purchasing team that helps with the raw material procurement process, the sales team, and the security department.
- Other overhead costs include other costs, such as building rental costs, machine depreciation, raw material delivery costs, utilities (water, electricity, gas), and so on.
If written in a formula, overhead costs can be calculated in the following way:
Total Overhead Cost = Indirect Material Cost + Indirect Labor Cost + Other Overhead Cost
How to Calculate Production Costs
As mentioned earlier, the production process gives rise to direct costs and indirect costs.
Direct costs include all costs directly involved in the production process, while indirect costs are costs that indirectly support the production process.
Thus, the production cost calculation can be done by adding up the total costs mentioned above. Here’s the formula:
Total Production Cost = Direct Material Cost + Direct Labor Cost + Total Overhead Cost
Meanwhile, to determine the product cost per unit, you need to divide the total production costs by the number of units produced in the period covered by those costs.
Cost of Goods per Unit = Total Production Costs : Number of Units Produced
Example of Calculating Fruit Juice Production Costs
Mrs. Untung and Mr. Untung are opening a new business called Healthy Juice, which sells a variety of fruit and vegetable juices. To determine the right selling price, Mrs. Untung and Mr. Untung must first calculate their production costs using the following information:
- The total cost for purchasing various fruits and vegetables, sugar, water, and ice cubes is Rp. 4,500,000.00 per month.
- The total cost incurred to pay the wages of production employees is IDR 750,000.00 and currently they are assisted by 3 employees.
- The total indirect costs incurred to pay for packaging, marketing staff, and other costs are IDR 10,000,000.00 per month.
With the above costs, Healthy Juice can produce 1,000 bottles of juice. Approximately what would be the selling price per bottle if Mr. Untung and Mrs. Untung desired a 20% profit margin?
- Calculating Total Production Costs
Total Production Cost = 4,500,000 + (3 x 750,000) + 10,000,000
= Rp. 16,750,000.00
- Calculating Cost of Goods Sold per Unit
Cost per Unit = 16,750,000 : 1,000
= Rp 16.750
- Calculating Product Selling Price
Product Selling Price = Cost of Goods per Unit + (Cost of Goods per Unit x Profit Margin Percentage)
= 16.750 + (20% x 16.750)
= 16.750 + 3.350
= Rp 20.100,00
Therefore, Mr. Untung and Mrs. Untung must sell each bottle of juice at Rp 20,100.00 to achieve the desired profit margin. Of course, this pricing strategy must be complemented by other business strategies to achieve this target.
That concludes our information on calculating production costs. We hope this information is as helpful as Labamu, which offers a wide range of features to support your MSME business. Download the app now via Google Play or the App Store. dan dapatkan manfaatnya!
