Production Cost Formula Definition
Production cost refers to all the direct and indirect costs that are incurred in the product’s production. These are– labor costs, raw materials, shipping costs, manufacturing supplies, and so on. The three main categories of production costs are–
- direct labor cost
- direct material cost
- factory overhead cost
Significance of Production Cost Formula
Production cost formula holds utmost importance in an e-commerce company’s economy as it helps to estimate net profit or loss on product sales. The formula also has to offer several other benefits like:
- It helps improve the financial health of a business with the data on profit or loss
- It helps the company maintain the budget and follow judicious spending
- It is also used in marketing and sales
- It can also evaluate fulfillment and shipping costs
Applications of Production Cost Formula
With the production cost in hand, companies can set the maximum retail price of the products. Check applications for production cost formula here:
- If production costs exceed the profit, companies can change processes to stay within budget
- Production cost determines the sales price for the finished products and helps e-commerce businesses increase their profitability.
Production Cost Formula
Cost of production formula =
Direct Labor Cost + Direct Material Cost + Manufacturing Overhead Cost
Direct Labor Cost = Hourly salary, healthcare benefits, etc.
Direct Material Cost = Raw materials’ cost required to produce the product.
Manufacturing Overhead Cost = Electricity, office bills, maintenance cost, etc.
Understanding With the Help of an Example
Suppose a notebook manufacturing company needs raw materials such as paper, cardboard, ink, stencil, glue, etc. The total cost of raw materials, i.e., direct material cost comes out to be A$1000.
Next are the workers that are working on manufacturing the notebooks. There are three workers total who charge A$700 a month. So the direct labor cost would be A$700 X 3 = A$21,000.
And lastly, the fixed factory overhead costs around A$500 a month.
Therefore, by applying the production cost formula, you get the following:
A$1000 + A$21,000 + A$500 = A$22,500 is your total production cost.
Calculating production costs helps determine the cost of materials, tax rates, technology, exchange rates, customers’ demand, and many other things.