Understanding How to Calculate Production Costs and their Components

For those of you who have been involved in the manufacturing industry, the concept of production costs will be familiar, because they are routine activities commonly carried out within a company.

Production costs are a crucial element in a business’s financial management, because this calculation includes various cost items serving as benchmarks for the success of product sales. 

The following blog unpacks what production costs are and how to calculate them for the success of your business enterprise.

‍

Understanding Production Costs

‍

‍

The cost of manufactured goods is an itemized list of expenses that a company incurs over a specific time period, with the items on this expense list relative to the costs of acquiring raw materials, equipment, and other production supports.

Once the total cost of manufactured goods is determined, the company can set product prices more easily, and with this, the profit and loss from the products to be sold can be accurately calculated.

The benefits of knowing the cost of manufactured goods help management analyze control over purchasing costs, and the cost of labor, which consist of wages or salaries paid monthly, with another benefit of costing manufactured goods being the knowledge of the business’s gross margin, and the ability to analyze the percentile of its available income, with the goal that these costs cover the company’s overall operational costs.   

‍

What Are the Components of the Cost of Goods Manufactured?

There are three components used to calculate the cost of goods manufactured; direct material costs, labor costs, and factory overhead costs:

1. Direct Material Costs

The first component of the cost of goods (COGS) manufactured is their direct material costs. 

The company relies on a management system that includes:

• Stopping the supply of raw material inventory;
• Calculating the amount of raw materials; 
• Calculating the cost of raw materials purchased; and 
• Calculating the total raw materials at the end of the defined time period

2. Labor Cost

The second component of COGS is labor costs. 

Accounting and payroll records ensure that the cost of goods manufactured can be easily calculated, however, this figure not only includes the wages that have been paid but also costs associated with the labor involved in the overall production process.

3. Factory Overhead Costs

Lastly, the component is factory overhead costs - Items that are considered parallel to direct costs, such as:  

• Indirect materials from office supplies that are used as factory equipment; and 
• Indirect labor used, such as accounting, facility maintenance personnel, human resources, management, and purchasing. 

Overhead cost, which includes;

• Depreciation of factory equipment; 
• Depreciation of buildings; and 
• Insurance and taxes on each factory building.

‍

Difference Between Cost of Goods Manufactured and Cost of Sales

‍

‍

Next, you also need to understand the difference between the cost of goods manufactured and the cost of goods sold.

The cost of goods sold refers to the total accumulation of all costs incurred to create a product or service that will be sold or offered to consumers, whereas the cost of goods manufactured is an effort to acquire assets or services during the production process, whether in the form of semi-finished goods or products ready for marketing.

Although they are different, the cost of goods manufactured is actually part of the cost of goods sold, however, without the calculation of production costs, the cost of goods sold cannot be determined.
‍

Read More: Understanding Cost of Goods Sold and How to Calculate It

‍

How to Calculate the Cost of Goods Manufactured

Step 1

Firstly, the formula to determine the cost of goods manufactured can be done by calculating the raw materials used.  The calculation formula is as follows:
‍

"Beginning Raw Material Balance + Raw Material Purchases – Ending Raw Material Balance = Raw Materials Used."

Step 2‍

Secondly, the formula to determine the cost of goods manufactured can also be done by calculating production costs. 

The calculation formula is as follows:
‍

"Raw Materials Used + Direct Labor Costs + Production Overhead = Total Production Costs."

Step 3‍

Finally, the formula to determine the cost of goods manufactured is as follows:

Total Production Costs + Beginning Work in Progress Inventory – Ending Work in Progress Inventory = Cost of Goods Manufactured.

‍

‍

The aforementioned are the definitions, components, and formulas used to calculate the cost of goods  (COGS) manufactured. 

Once done, your business can set the prices for products or services to be sold, helping your business achieve its maximum profit.

To help you in managing your business, Youtap’s POS is a digital cashier application from Youtap Indonesia, which has a  variety of features that will make all of your business operational activities easier, faster, and more practical, and your business no longer needing to manually record transactions, as they will be automated, even when your business is conducting analysis.

Moreover, there are also several additional advanced features you can use to manage your business. 

For example, to calculate the COGS manufactured in the Youtap POS Cashier Application, you can use the Product Management feature, which makes it easier for business owners to determine the COGS manufactured, its cost price, and the selling price for each product. 

This way, business owners will know the profit from each product sold. 

Are you curious about how the Youtap POS Cashier Application features work? 

Download it from the Google Play Store or App Store and register your business in the Youtap ecosystem now!

You won’t be disappointed!