- What are production costs?
- Elements of production costs
- Types of production costs
- Production cost examples
- Other types of costs
We explain what production costs are, the elements that compose them and the types that exist. Also, examples explained.
What are production costs?
In accounting, production costs or operating costs are the series of expenses that involves sustaining a project, team or business running. They can come from different areas, be it the purchase of inputs or raw material, the payment of the consumption of Energy, the salary of workers or equipment maintenance.
By definition they are intrinsic expenses of the productive process. In other words, producing, in principle, costs money. That is why, once the production circuit is finished, the production costs are subtracted from the income to determine the Profits gross.
If these costs (and the others generated along the production chain) turn out to be very high, this affects the final price of the product and the cost effectiveness of the operation, since every investor wants to recover the amount spent and receive some type of profit later.
Elements of production costs
When talking about production costs, we are referring broadly to three different variables:
- Direct raw material (MPD). The set of materials that will be subjected to transformation during the production process, and that can be fully identified or quantified with the products finished.
- Direct Labor (MOD). The set of expenses involved in hiring workers: wages, benefits, contractual and union obligations, etc., which in the end can be identified or quantified with the finished products.
- Indirect Manufacturing Expenses (GIF). Also called indirect charges, they are that set of costs that, although they intervene in the production process, they cannot be fully quantified or identified with the elaboration of specific accounting items.
Types of production costs
Production expenses are classified into two: variable or fixed.
- Variable costs. Those that are proportional to production, such as the value of raw material, payment of direct labor, supervision of labor, maintenance of equipment, services consumed, required supplies, royalties and patents, and packaging or containers, if any.
- Fixed costs. Those that are independent of production, such as taxes, insurance, levies, financing, public relations, accounting and auditing, the marketing, legal advice, etc.
Production cost examples
Suppose we run a chocolate candy factory, which each day produces dozens of units that are packaged and put on the market, where they are consumed by a child audience. What would our operating costs be?
Variable operating costs:
- Raw material. The price of cocoa, sugar, milk and flour, which fluctuate in the market according to their offer Y demand.
- Workforce. The workers who operate the different machines to make the chocolate bars, in their different positions and hierarchies, including workers and supervisors.
- Maintenance. The payment of cleaning, calibration and spare parts services for the factory's specialized equipment, as well as the software who manages it.
- Services. Gas is consumed in the process, Water, electricity and another company is hired that manufactures the wrappers for each chocolate bar, out of a paper printed with motifs.
- Patent. For each chocolate bar produced we must pay a copyright of the recipe to its inventor.
Fixed operating costs:
- Taxes. We must pay at Condition a tax quota for the economic activity that we carry out, as well as a series of contributions to social security and to the retirement fund of our employees in the factory, in accordance with the legal provisions.
- Rentals. Both the place where we have located our factory, as well as the equipment that is not owned by us.
- Marketing. We will pay for the advertisements of our chocolates in newspapers, TV and radio, to promote them and make the public look for them. This also involves hiring designers to renew the appearance of the product from time to time.
Other types of costs
In addition to operating costs, there are the following types of costs:
- Distribution costs. Those that take place when the production cycle has ended, and it is necessary to take the product to its consumers. Distribution can be done in many ways, generally massive, and serves as an intermediary between the factory and the store.
- Administration costs. Those that involve managerial, accounting, legal and other administrative process personnel that are not directly involved in production, but that are essential for the well-being of the company.
- Financing costs. Those that have to do with loans, mortgages, refunds and other mechanisms to obtain the initial money of the company, which then has to be returned or repaid.