The Meaning, Types and Calculation of Cost of Production
When you buy something from the market, you pay the MRP, or maximum retail price. The product’s initial manufacturing cost was far lower than its suggested retail price. Production expenses and trader profits further cover the enormous gap between MRP and manufacturing price.
How is the cost of an article’s production calculated? What kinds are there? What makes it different from production expenses, and why?
Production costs and cost price are other names for the cost of production. It is the overall expense incurred by a company to manufacture a certain quantity of a good. It comprises all of the product’s manufacturing expenses, including direct and indirect.
Simply put, the cost of manufacturing is the product’s initial cost, minus wholesaler, retailer, and other intermediary profits.
Numerous direct and indirect expenses that are incurred during the manufacturing process are included in the cost of production. The following ancillary charges are included in the cost of production:
- Raw material price
- The price of labour needed in the production process
- Storage fees
- Expenditures towards technology
- The expense of maintaining the infrastructure and equipment used
- Land and capital investment costs
How to Calculate the Cost of Production
A manufacturing unit’s total direct and indirect expenses can be added to determine the cost of production, cost price, or production costs. The cost of production calculation formula is shown below.
Total production costs equal the cost of labour. Cost of raw materials, often known as manufacturing overhead costs.
The Importance of Cost of Production
The following justifications support the notion that cost of production is a crucial concept in economics:
- It aids in calculating the product sales’ net profit or loss.
- It aids the manufacturer in determining the highest suggested retail price for his goods.
- It assists the government in determining a product’s minimum support price as well as the price floor and maximum.
Types of Cost of Production
Fixed Cost
Prices that don’t fluctuate over time are considered to be fixed expenses. As the name implies, fixed costs don’t change over time. The volume of manufacturing has no impact on these expenses.
Even in cases of no production or loss, producers must nevertheless cover fixed costs.
A farmer borrowed money to buy a land for farming. He makes a good harvest and profits one season, but his crops collapse the following. Nevertheless, regardless of earnings or losses, he is still required to pay the loan rate interest
Variable Cost
Production-related costs are known as variable costs. Variable expenses fluctuate at varying rates, as their name implies. It fluctuates from time to time. Production sales have a direct impact on variable costs. Variable costs rise in tandem with production sales, and vice versa.
Total Cost
The sum of the fixed and variable costs is the total cost.
Average Cost
The total cost of manufacturing divided by the number of units produced is known as the average cost of production. Simply said, average cost is calculated by dividing the total cost of production by the quantity of units produced.
Marginal Cost
Each business generates a few extra products to cover unintentional causes or damages. Marginal costs are expenses incurred while producing an additional amount. Fixed costs are unaffected by marginal costs. However, it drives up the variable cost.
The average cost is equal to or less than marginal expenses.
Cost of Production and Manufacturing Cost – The Difference
Sometimes individuals confuse manufacturing costs with the cost of production or production expenses. However, the costs associated with production and manufacturing are distinct. While the cost of manufacturing is the sum of several costs. Production costs, sometimes known as the cost of production, include manufacturing costs.
While the immediate costs incurred for the product’s manufacturing and marketing are included in the cost of production, the expenditures associated with its construction are covered by the manufacturing costs.
For instance, the cost of renting a building is accounted for in production expenses but not in manufacturing costs. Costs associated with materials and labour used in the law are included in both manufacturing costs and production costs.
Once more, transportation costs and marketing promotional costs are included in the cost of production but not in the cost of manufacturing.
An essential component of the manufacturing process is the cost of production. The final price of commodities is determined by the cost of production. The cost of production also influences the price floor and ceiling. As a result, the importance of production cost in managing market flow increases.
To lower the cost of production for producers, the Indian government has introduced numerous initiatives. This could be the outcome of offering the producer a free service or free infrastructure.
