What is the Production Cost Formula?

The production cost formula is composed of costs that the business or a company incurs in making finished goods or delivering specific services and includes typically direct labor, general overhead expenses, direct material expenses, or expenses on raw materials and supplies.

The production costs should be directly aligned with the business’s revenue generation. The manufacturing business typically has raw materials costs and labor costs. In contrast, the specific service industry is composed of technical labor developing a specific service and material costs incurred in delivering such services to the clients. The production cost formula is generally used in managerial accounting to segregate costs into direct and indirect costs.

The production cost formula can be expressed as follows: –

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Here,

Overhead costs on manufacturing= Indirect labor cost + Indirect Material cost + Other variable overhead costs.

Explanation of the Total Production Cost Formula

Examples of Total Production Cost Formula (with Excel Template)

Let’s see some simple to advanced examples of Production Cost Equation to understand it better.

  • Firstly, Determine the costs of direct material. Direct materials are usually composed of costs related to the procurement of raw materials and utilizing them to produce finished goods. Next, determine the costs of direct labor. The direct labor cost is usually composed of costs on labor costs and costs of the workforce that are in line with the production process. Such costs generally consist of wages, salaries, and the benefits the business compensates to the labor for delivering finished goods or services. Next, Determine the costs of manufacturing. Such costs typically comprise costs that cannot be attributed to the production process but indirectly impact the production. Such costs can be bifurcated into indirect labor costs, indirect material costs, and variable costs on overhead. Next, add the resulting value in steps 1, step 2, and step 3 to arrive at the cost of production.

Production Cost Formula – Example #1

Let us take the example of a manufacturing business that incurs $25,000 indirect labor. It incurs $30,000 in manufacturing overheads and $50,000 in direct material costs. Help the business to determine the overall cost of production.

Use the given data for the calculation of production cost.

Calculation of Production Cost can be done as follows:

  • = $25,000 + $50,000 + $30,000

Production Cost will be  –

  • Production Cost = $105,000

Therefore, the manufacturing business incurs a production cost of $105,000 when manufacturing finished goods.

Production Cost Formula – Example #2

Let us take the example of a business that specializes in producing chairs. The raw material cost accounts for $75,000. The wages and salaries for the labor and workers account for $40,000. The company compensates benefits worth $3,000 to the labor for delivering exceptional service. The company additionally bears once in a while polishing costs on chairs of $30,000.

The business stores the finished chairs in a rented warehouse. They pay a rental amount of $20,000. They additionally pay $15,000 as the wage for security guards. Help the business of finished chairs to determine the cost of production.

Calculation of Direct Labor using below formula can be done as follows,

Direct labor = Wages of Production Workers + Benefits of the Production Workers

  • = $40,000 + $3,000Direct Labor = $43,000

The direct material costsDirect Material CostsDirect Material Cost is the total cost incurred by the company in purchasing the raw material along with the cost of other components including packaging, freight and storage costs, taxes, etc. that are related directly to the manufacturing and production of various products of the company.read more correspond to the cost of raw material procured by the business, which would be regarded as $75,000. The manufacturing costs would account for the sum of polishing, rental expenses, and wages for the security guards.

Calculation of Manufacturing Cost using below formula can be done as follows,

Manufacturing Cost = Polishing Cost + Rental Expense+ Wage for Security Personnel

  • = $30,000 + $20,000 + $15,000Manufacturing Cost = $65,000

  • = $43,000 + $75,000 + $65,000

  • Production Cost = $183,000

Therefore, the manufacturing business incurs a production cost of $183,000 when manufacturing chairs.

Relevance and Uses

The determination of the production costs formula is necessary as well as critical for the business to ensure its profitability of the businessProfitability Of The BusinessProfitability refers to a company’s ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company’s performance.read more and sustainability. It also helps in the comparative analysis of the costs. Once the manufactured items reach completion, the business records the item’s value as an asset on the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders’ equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner’s capital equals the total assets of the company.read more  until the product is sold to the customers.

The production cost has to be initially capitalized and not expensed. Additionally, reporting the value of the end products could be termed as a sophisticated way to inform all the necessary stakeholders on the level of productivity that is being delivered.

This article has been a guide to Production Cost Formula. Here we discuss how to calculate total production cost in excel using its formula along with examples and a downloadable excel template. You can learn more about financial analysis from the following articles –

  • Churn Rate FormulaTangible Net Worth FormulaExamples of Product CostPeriod Cost vs Product CostPeriod Cost Vs Product CostProduct cost is the cost incurred by the company only if it produces any products and those costs are apportioned to a product. Period costs are costs incurred by the company with the passage of time that are not apportioned to any particular product.read more