Production Costs vs Manufacturing Costs: An Overview
Production costs reflect all the expenses associated with a business doing business while manufacturing costs only represent the expenses necessary to manufacture the product.
These two numbers are used to assess the total operating expenses of a manufacturing business. The revenue that a company generates must exceed the total expense before reaching profitability.
Key points to remember
- The production costs of a factory are the total expenses for doing business.
- Manufacturing costs are the expenses directly related to the manufacture of the product.
- Production costs and manufacturing costs must be included in the calculation of the cost per item of doing business.
Production costs include many of the fixed and variable costs of running a business. Raw materials and labor are production costs.
Fixed costs generally include:
Variable costs increase or decrease as the volume of production changes. Some variable costs are:
- Any other expense that changes with the level of production
Manufacturing companies calculate their overall expenses in terms of production cost per item. This number is, of course, essential in setting the wholesale price of the item.
As the production rate increases, the company’s revenue increases while its fixed costs remain stable. Therefore, the manufacturing cost per item decreases and the business becomes more profitable.
A lower fixed cost per item motivates many companies to continue to ramp up production to full capacity. This allows the company to earn a higher profit margin after taking into account all the variable costs.
Manufacturing costs, for the most part, are sensitive to changes in production volume. Total manufacturing expenses increase as production increases.
The ability to achieve a lower fixed cost per item motivates many companies to continue to ramp up production to full capacity.
The cost per item does not change significantly. However, additional production always generates additional manufacturing costs.
Manufacturing costs fall into three broad expense categories: materials, labor, and overhead. All are direct costs. That is, the company accountant’s salary or the accountant’s office supplies are not included, but the foreman’s salary and supplies are.
Production Costs vs Manufacturing Costs Example
For example, a small business that manufactures widgets may have fixed monthly costs of $800 for its building and $100 for equipment maintenance. These expenses remain the same regardless of production level, so per-item costs are reduced if the company makes more widgets.
In this example, the total production costs are $900 per month in fixed expenses plus $10 in variable expenses for each widget produced. To produce each widget, the company must purchase supplies at $10 each. Each widget sells for $100. After subtracting the manufacturing cost from $10, each widget earns the company $90.
To break even, the company must produce 10 widgets every month. He must make more than 10 widgets to become profitable.