Understanding Production Costs, Components, and How to Calculate Them

For those of you who have been involved in the manufacturing industry for a long time, the concept of production costs will be quite familiar. This is because production costs are routine activities commonly carried out in a company.

Moreover, production costs are also a crucial element in financial management. The reason is that this calculation includes various cost items that can serve as benchmarks for the success of product sales. If you are not yet familiar with what production costs are and how to calculate them, let’s take a look at the complete explanation below.

Understanding Production Costs

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The cost of goods manufactured is a list of expenses that a company needs to incur over a specific period. The items on this expense list relate to the costs of acquiring raw materials, equipment, and other production supports. Once the total cost of goods manufactured is determined, the company can more easily set product prices. This way, the profit and loss from the business products to be sold can be accurately calculated.

The benefits of knowing the cost of goods manufactured include helping management analyze control over purchasing costs and labor costs, which usually consist of wages or salaries paid monthly. Additionally, another benefit of the cost of goods manufactured is to understand the gross margin of the business and analyze the percentage of available income, with the goal of covering the company's operational costs.

What Are the Components of the Cost of Goods Manufactured?

There are three components in calculating the cost, which are direct material costs, labor costs, and factory overhead costs. Here’s the explanation:

1. Direct Material Costs

The first component of the cost of goods manufactured is 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.
• Calculating the total raw materials at the end of the period

2. Labor Cost

The second component of the cost of goods manufactured is labor costs. Accounting and payroll records can ensure that the cost of goods manufactured is an easily calculated figure. However, this not only includes the wages that have been paid but also includes costs associated with labor involved in the production process.

3. Factory Overhead Costs

Lastly, the component is factory overhead costs. Items considered parallel to direct costs include:

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

Overhead cost, which include;

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

Difference Between Cost of Goods Manufactured and Cost of Sales

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Next, you also need to understand the difference between the cost of goods manufactured and the cost of goods sold. When discussing the cost of goods sold, it refers to the total accumulation of all costs incurred to create a product or service that will be sold or offered to consumers. Meanwhile, 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. Without the calculation of production costs, the cost of goods sold cannot be determined.

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

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How to Calculate the Cost of Goods Manufactured

Step 1

The formula to determine the cost of goods manufactured can be done by calculating the raw materials used. Here’s the calculation formula:
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"Beginning Raw Material Balance + Raw Material Purchases – Ending Raw Material Balance = Raw Materials Used."

Step 2‍

Next, the formula to determine the cost of goods manufactured can also be done by calculating production costs. The formula is:
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"Raw Materials Used + Direct Labor Costs + Production Overhead = Total Production Costs."

Step 3‍

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

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

That’s the definition, components, and how to calculate the cost of goods manufactured. Once successfully done, you can easily set the prices for products or services to be sold, helping to achieve maximum profit.

In managing your business, you can use Youtap POS, a digital cashier application from Youtap Indonesia. This application has various features that will make all business operational activities easier, more practical, and faster. You no longer need to manually record transactions, as it will be automated, even for the analysis part. But that’s not all; there are also several other advanced features you can use to manage your business.

To calculate the cost of goods manufactured in the Youtap POS cashier application, you can use the product management feature, which makes it easier for business owners to determine the cost of goods manufactured, cost price, and selling price for each product. This way, business owners will know the profit from each product sold. Curious about how the Youtap POS features work? Download it from Google Play Store or App Store and register your business in the Youtap ecosystem now!