What every manager needs to know about production costs
In order to make the right decision on pricing, and understanding on profitability of various profit centers (production lines), it is necessary to have timely information about the costs that these profit centers produce, and correctly determine their ultimate profitability and benefit for the organization as a whole.
We don't have to wait for the year end to know where we are at.
Groups of costs
All company costs are not production ones. All production costs are not allocated to every production line. To understand the production costs, the simplest thing to imagine is that these are the costs that participated in turning the raw material into the end product.
Let's start by clarifying the direct and indirect costs. Direct costs are easiest to understand if we can accurately identify them in what quantity and at what value they participated in the production of this product. These are the raw materials that we spent for the production of products, as well as direct hours of labor spent in the production. However, for production of the end products we also used i.e. electricity, space, and depreciation costs. All such costs are production costs, which are allocated to the production lines based on allocation keys. These costs are called indirect costs. The allocation key, for the example of the production of two products A and B, can be the quantity of units produced for each one. For example, if we use the same office space for the production of two products, which has a unique invoice for rent, electricity and other utilities, the organization can use the allocation key of the quantity of products produced units for each product to assign the corresponding cost value to Product A and Product B.
Additionally, costs may be divided in fixed and variable ones. Fixed costs are not absolutely dependent on the number of units produced. The most common example is the depreciation of fixed assets, which may be the same, regardless of whether we have produced more or less planned units of production for the day.
All costs are not production costs. Production costs that are not included in the production calculation include sales costs, marketing costs, administrative costs that did not participate in the production process, etc.
“Before you start, count the cost first. Then, once you start, quitting is never an option.”
― Isaac A. Yowetu
Why do we have to know this?
Once the organization decides on the
Costs that participate in and do not participate in production costs;
Which are direct and indirect; fixed and variable;
Allocation keys for allocating indirect costs to production lines;
It can make more efficient decisions about:
optimization of resources;
profitability of individual production lines;
assessment of the efficiency and productivity of workers and remuneration according to the same;
decision-making on pricing schedules.
Service companies can also monitor costs in the same way as production companies. Difference wo the production organizations which costs are primarily loaded with raw materials, service organizations are mainly charged for labor costs, where allocation of indirect costs same as in production organization may apply. In this case, labor hour instead of production quantity may apply as appropriate allocation key.
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We wish you a happy calculating of your expenses,