We explain what production costs are, the elements that make them up and the types that exist. Also, examples explained.
What are production costs?
In accounting, production costs or operating costs are the series of expenses involved in keeping a project, team, or company running. They can come from different areas, be it the purchase of inputs or raw materials, the payment of energy consumption, the salary of workers or the maintenance of equipment.
By definition are intrinsic expenses of the production process. That is, producing, in principle, costs money. That is why, once the production circuit is completed, production costs are subtracted from income to determine gross profits.
If these costs (and the others generated throughout the production chain) turn out to be very high, this affects the final price of the product and the profitability of the operation, since every investor wants to recover the amount spent and receive some kind of of profit later.
See also: Cost accounting
Elements of production costs
When talking about production costs, we are broadly referring 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 finished products.
- Direct labor (MOD) The set of expenses involved in hiring workers: salaries, benefits, contractual and union obligations, etc., which in the end can be identified or quantified with the finished products.
- Manufacturing indirect expenses (GIF) Also called indirect charges, they are a set of costs that, although they are involved in the production process, cannot be fully quantified or identified with the preparation 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 materials, payment of direct labor, supervision of labor, maintenance of equipment, services consumed, supplies required, royalties and patents, and the packaging or containers, if any.
- Fixed costs Those that are independent of production, such as taxes, insurance, liens, financing, public relations, accounting and auditing, marketing, legal advice, etc.
Examples of production costs
Suppose we manage a chocolate candy factory, which produces dozens of units every day that are packaged and put on the market, where they are consumed by a children's 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 supply and demand.
- Labour The workers who operate the different machines to manufacture the chocolate bars, in their different positions and hierarchies, including workers and supervisors.
- Maintenance Payment for cleaning, calibration and spare parts services for the factory's specialized equipment, as well as the software that manages it.
- Services In the process, gas, water, electricity is consumed and another company is hired to manufacture the wrappers for each chocolate bar, made of paper printed with motifs.
- Patent For each chocolate bar produced we must pay a recipe copyright to its inventor.
Fixed operating costs:
- Taxes. We must pay the State a tax fee for the economic activity we carry out, as well as a series of contributions to social security and the retirement fund of our factory employees, in accordance with legal provisions.
- Rentals. Both the place where we have located our factory, and the equipment that is not our property.
- Marketing. We will pay for advertisements for our chocolates in newspapers, television and radio, to promote them and for the public to search 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 bring 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 management, accounting, legal and other administrative processes that are not directly involved in production, but are essential to the well-being of the company.
- Financing costs Those that have to do with loans, mortgages, returns and other mechanisms to obtain the initial money from the company, which then has to be returned or repaid.
Continue with: Means of production
References
- “Cost accounting” on Wikipedia.
- “What are production costs?” in Classroom more$s/.
- “Elements of production cost” (video) in GlobalStone Investment.
- “Production costs” in WS Economics.
- “The types of costs and how they can be classified according to the parameters you need to measure” in Gestion.org.
- “Production Costs” in Investopedia (English).
