Examining the cost of production is one of the most important steps in the production process. Businessmen are always interested in the cost of production to determine the price of their products, determine profit margins, value of assets, and make optimal decisions. As you can see, the cost of production is actually the same amount that a unit of production uses to buy or rent production inputs.
Production cost is an important factor in the process of producing or delivering a product in any company. Understanding how production costs are calculated, recorded, and controlled is an essential part of ensuring the cost-effectiveness and profitability of companies’ products. To understand the cost of producing types of products, you have to know the cost of production and how it affects the success of the company.
Definition of cost of production
The term “production cost” refers to all costs incurred by a company when providing services or producing a product. Production costs include a variety of costs, including raw materials, employee salaries, plant maintenance, and transportation costs; Also, costs such as income taxes associated with production operations or a company’s facilities are classified as production costs.
Companies calculate the cost of production in terms of “cost per unit of product,” which includes the amount of money needed to produce a particular item. To calculate the cost per unit of product, accountants calculate the cost of production and then divide it by the number of units produced. Next, they can consider the cost per unit. of the product and determine how to price the product for sale.
Usually, companies need to sell items to make a profit greater than their cost of producing them. If the cost of producing the product is equal to or greater than its selling price, the company is at risk of loss or failure; For this reason, we can say that production costs are an important factor that companies should consider when evaluating the success of their financial situation. If the cost of producing a product consistently exceeds profits, the company may need to stop production to maintain its budget. Likewise, if the costs of providing a particular service become too high, the company must stop providing that service or find a way to reduce the costs associated with it.
types of production costs
Production costs can be divided into two separate categories, which include direct and indirect costs.
1- The direct cost of production
Direct costs are costs that are directly evaluated as the cost of products, services, customers, or other items of manufactured products.
Corporate accounting teams usually record direct costs at each stage of the production process and then aggregate them to get the total cost of producing each product. Direct costs are often variable, which means they can fluctuate depending on various factors; For example, the price of oil required by production equipment may be higher or lower each year, and similarly, a change in the minimum wage may increase the hourly wages of lower-level workers.
In general, direct costs include:
The worker’s salary
2- The indirect cost of production
Indirect costs are the costs associated with the production process, but which cannot be estimated directly in the production process.
Some indirect costs cannot be considered a factor in the cost of producing a particular product; Instead, these costs are part of the general production costs.
Indirect production costs include costs that facilitate the process of producing a product or service without directly affecting the process. Identifying, recording, and controlling overhead production overhead costs is one of the most effective ways to reduce a company’s production costs.
Some of the most important overhead costs of production are:
The cost of office supplies
Building water and electricity funds
Salaries of supervisors or support staff
The cost of renting the company’s headquarters
What is the difference between direct production cost and indirect production cost?
Direct production cost is the same as real payments such as wages and rent. Indirect production cost has different classifications, but generally includes the opportunity cost that arises from the allocation of scarce resources to a particular situation and for which no specific monetary value can be considered.
Indirect costs cannot be easily identified, are not reported, and are generally intangible. For example, the time spent training a new workforce is the same as the time spent carrying out new business activities, which could be used for more important tasks. Opportunity cost is The same indirect cost or the cost of ignoring the second best option.
For example, if the home appliance company used the same amount to train a new workforce instead of investing in a new line of refrigerators, the opportunity cost of making a profit from producing the new refrigerators would be an indirect cost.
In most cases, costs consist of an indirect part and a direct part, for example, if a company’s printing machine has a problem, the cost paid to the repairman and parts replacement, the direct cost and the production time spent to fix the machine because of its failure, is considered an indirect cost.
What is the economic cost?
Economic Cost is actually the sum of direct and indirect costs. When evaluating the profitability of a company’s business performance, management pays attention to its direct costs to determine its productivity. However, management may consider direct and indirect costs to determine the total return on total costs. relating to revenue incurred in making a decision or choosing between various options.
For example, if a person leaves work for an hour to purchase work supplies, and the cost of providing those supplies is $90, then the direct cost is $90.
If that person earns $3 per hour and is not at work to provide services, the company loses another $3. This means that the cost is minimized
The total payment for the workplace would be $903.
Factors affecting production costs
Several specific factors can significantly affect the cost of producing a particular product or service; Some of these factors are:
1- The request
As companies grow, demand for certain products increases. A company may need to purchase more raw materials, hire new workers, expand production facilities, or even open a second plant to fulfill customer orders. Ideally, a company can use the profits of its new customers to compensate Additional costs of additional production.
As technology advances, some companies that were traditionally managed by manpower are moving to complete tasks by means of machines and automated systems. Many companies prefer to use manufacturing robots instead of employees; In this way, their company’s manpower costs are reduced.
In addition, updating factory equipment, installing new computer systems, or training employees to use new digital interfaces can speed up the production process as well as reduce production costs.
3- The price of the currency
If a company imports its raw materials from abroad, the currency rate at the time the materials are purchased can greatly affect the cost of production. If the currency price rises, the materials that the company needs to produce its products will become cheaper; However, higher currency rates can reduce competition among exporting firms; In this way, costs may remain constant or even increase as well.
4- The interest rate
The other indirect cost to companies is their loans, in other words, if the company borrows from a bank or other institution to pay the costs, then the interest rate on the loan can be increased or decreased. cost of production, companies should consider the possibility of fluctuations in interest rates on bank loans in their financial statements.
5- The cost of the material
The cost of raw materials for production can vary depending on the year of production, economic conditions and existing restrictions; For example, steel prices may rise or fall depending on the financial stability of the steel mill or the costs of international transportation, on the other hand, oil and gasoline prices are very influential in almost every industry because of their relationship to transportation and product delivery.
6- The tax rate
A tax is a company’s indirect production cost, which can greatly increase a company’s annual overhead costs. Corporate taxes may increase or decrease over the course of a year, depending on changes in government regulations. In this way, factors such as hiring many new employees can In the company and increase employee premiums and workers’ taxes to increase production costs.
What is the meaning of time unit in examining production cost?
The cost of production or the value of production resources can change based on the change in the quantity of production and products over time, therefore, production costs can also be divided according to the time period.
production cost in the long run
A “Long Run Cost” is the cost of a period of production in which the manufacturer can change the values of all the production inputs it uses (regardless of whether they are fixed or variable), meaning, by definition, in the long run, that all resources Productivity is subject to change, and none of it remains static.
When we can change all inputs to production, we have entered into a long-term period. Note that when determining whether a course is long-term or short-term, it is a relative definition, and each cycle can be considered shorter than the others, although all inputs can be changed. In the long run, the lowest cost production plans are generally chosen.
production cost in the short run
Short Run Cost is the cost of the period of time in which the enterprise is not able to change some of its production resources, in fact, in the short run, at least one of the factors of production remains unchanged, one of the sources of production is variable, and the value of the inputs The other is fixed, the short term has no exact definition.
That is, in developed countries, enterprises can change all sources of production within a year, and in developing countries, it may take decades. Simply put, a short-term period is a period in which a company cannot change resources such as expensive equipment such as buildings, land, and machinery.
In the short run, the cost of such expensive equipment as buildings, land, and machinery will remain constant because the manufacturer cannot change it.