In the dynamic world of business, mastering the cost of production formula is like having a compass that always points north.
For you, the warriors of MSMEs and adventurous business owners, understanding these details is not just about numbers, but about navigating your business towards the peak of success.
Let us prepare for a journey, navigating the seas of business with the most valuable map: knowledge of the cost of production.
Definition of Cost of Production
COGS is the total cost incurred to produce goods or services ready for sale. It’s not just about the money spent on raw materials, but also about how energy, time, and other resources collaborate to create something valuable.
In the vibrant world of business, the cost of production is like a canvas you will paint with strategy and innovation.
3 Important Components of Cost of Production
Raw materials, direct labor, and factory overhead are not just figures in financial reports; they are the most important metrics that bring your product to life.
Let’s delve deeper into these three components and why they are inseparable in building your business empire.
1. Raw Materials
Raw materials, the heart of every creation, are the shining stars in your production. Like seeds that grow into lush trees, raw materials are the foundation of every product you offer.
But remember, just as the quality of the seed determines the quality of the tree, so too does the quality of raw materials determine the quality of the final product.
When choosing raw materials, consider sustainable and ethical sources. This is not just about quality products, but also about building a positive image in the eyes of your customers.
2. Direct Labor
Then, there is direct labor, the artisans whose hard work is often hidden behind the glamour of the final product. They are the hands that carve, paint, and assemble, giving life to inert raw materials.
In this era of automation, do not forget the human touch that can add unique value to your product. Investing in their well-being and skill development will not only improve product quality but also foster loyalty and productivity.
3. Factory Overhead
Factory overhead, the director behind the scenes, coordinates all production elements to ensure that the show must go on. From the electricity that powers factory lights to machine maintenance that ensures smooth production, factory overhead comprises costs that are often unseen but vital for production.
In managing overhead, intelligence and innovation are key. For example, using renewable energy or process automation can significantly reduce these costs.
Harmonizing these three components to create production synergy is not an easy task. However, with the right strategy, you can create a captivating symphony.
For example, the use of the latest technology can optimize raw material usage and labor efficiency. Meanwhile, good waste management practices can reduce factory overhead while contributing to environmental sustainability.
Read also: Pricing Strategies: Definition, Factors, and 25 Types
Cost of Production Formulas
After understanding the importance of the Cost of Production (COGS) in business, let’s delve deeper into this matter. In this fast-paced world, mastering the COGS formula is like having a treasure map.
This time, we will explore three important formulas that can make you a skilled captain in steering your business ship.
1. Basic Cost of Production Formula
First, there is the basic COGS formula, which is like the foundation for a building. The formula is quite simple:
COGS = Raw Material Costs + Direct Labor Costs + Factory Overhead Costs
The definition of this formula is the total cost incurred to produce goods. Its purpose, of course, is to calculate the necessary costs so you can set the right selling price.
Example of calculating the basic cost of production formula:
For example, if your raw material cost is Rp10,000, direct labor cost is Rp5,000, and factory overhead cost is Rp3,000, then your COGS is Rp18,000.
2. Cost of Production Formula with Inventory
Next, we have the COGS formula with inventory, which is slightly more complex.
The formula is:
COGS = Beginning Inventory + Purchases – Ending Inventory
This formula is used to calculate production costs by considering the stock of goods you have. Its purpose is to obtain a more accurate picture of production costs by considering existing inventory.
Example of calculating the cost of production formula with inventory:
For example, if your beginning inventory is Rp5,000, purchases during the period are Rp20,000, and ending inventory is Rp4,000, then your COGS is Rp21,000.
3. Activity-Based Costing (ABC) Method
Finally, there is the Activity-Based Costing (ABC) method, which is like a dance with numbers. ABC is a method that allocates overhead costs to products and services based on the activities that consume those costs.
The formula can vary, but the basic principle is:
COGS = Raw Material Costs + Direct Labor Costs + (Overhead Cost per Activity × Number of Activities)
The ABC method aims to provide a more accurate picture of the costs associated with production. This allows businesses to more precisely assess the costs of each production component.
Example of calculating the cost of production formula using the Activity-Based Costing (ABC) method:
For example, if you have raw material costs of Rp10,000, direct labor costs of Rp5,000, an overhead cost per activity of Rp2,000, and the number of activities is 3, then your COGS according to the ABC method is Rp16,000.
Read also: Production Cost Calculation: Definition, Benefits, Cost Components, and Methods
Cost of Production Differs from Total Production Cost
Cost of production and total production cost are two different but equally important calculations. Let’s make this navigation easier with a comparison table and a real-world example to better understand this concept.
How to Calculate Cost of Production and Total Production Cost
Imagine you have a growing cookie business. For one 350-gram box of cookies, let’s calculate its COGS and total production cost:
- Raw Material Costs:
- Flour: Rp2,000
- Sugar: Rp1,500
- Eggs: Rp2,000
- Other ingredients (butter, chocolate, etc.): Rp3,000
- Total Raw Material Costs: Rp8,500
- Direct Labor Costs:
- Worker wages: Rp1,500
- Production Overhead Costs:
- Electricity: Rp500
- Equipment depreciation: Rp500
- Total Production Overhead Costs: Rp1,000
- Cost of Production (COGS) per Box:
- COGS = Raw Material Costs + Direct Labor Costs + Production Overhead Costs
- COGS = Rp8,500 + Rp1,500 + Rp1,000 = Rp11,000
- Total Production Costs:
- Administrative Costs: Rp1,000
- Marketing Costs: Rp1,500
- Total Production Costs per Box:
- Total Production Costs = COGS + Administrative Costs + Marketing Costs
- Total Production Costs = Rp11,000 + Rp1,000 + Rp1,500 = Rp13,500
Understanding the basic production cost formula is the first step on the long journey towards business success. However, no matter how far you go, Labamu is always ready to be your loyal companion.
Equipped with the ‘Manage Raw Materials’ feature, Labamu helps you manage cost of production components more detailed and comprehensively, ensuring every step of your business is calculated with precision and efficiency.
Visit our Labamu page and be part of the digital revolution in your business by downloading the Labamu app. Get a free Premium trial to open the door to ease, efficiency, and business growth.
With Labamu, every detail in your basic production cost formula will become your strength in achieving your dreams. Join us on this journey and turn every challenge into an opportunity with Labamu.
