Production Costs vs. Manufacturing Costs: An Overview
Production costs reflect all of the expenses associated with a company conducting its business while manufacturing costs represent only the expenses necessary to make the product.
Both of these figures are used to evaluate the total expenses of operating a manufacturing business. The revenue that a company generates must exceed the total expense before it achieves profitability.
- A factory's production costs are the total expenses of doing business.
- Its manufacturing costs are the expenses directly related to building the product.
- Both must be included in the calculation of the per-item cost of doing business.
Costs of production include many of the fixed and variable costs of operating a business. Raw materials and labor are production costs.
Fixed costs typically include:
- Building rent
- Advertising budget
- Business equipment
- Other miscellaneous expenses that do not go up or down with moderate changes in the volume of business
Variable costs increase or decrease as production volume changes. Some variable costs are:
- Any other expenses that change with the level of production
Manufacturing businesses calculate their overall expenses in terms of the cost of production per item. That number is, of course, critical to setting the wholesale price of the item.
As the rate of production increases, the company's revenue increases while its fixed costs remain steady. Therefore, the per-item cost of manufacturing falls and the business becomes more profitable.
A lower per-item fixed cost motivates many businesses to continue expanding production up to its total capacity. This allows the business to achieve a higher profit margin after considering all variable costs.
Manufacturing costs, for the most part, are sensitive to changes in production volume. Total manufacturing expenses increase as production increases.
The opportunity to achieve a lower per-item fixed cost motivates many businesses to continue expanding production up to total capacity.
The per-item cost does not change substantially. Nonetheless, additional production always generates additional manufacturing costs.
Manufacturing costs fall into three broad categories of expenses: materials, labor, and overhead. All are direct costs. That is, the salary of the company accountant or the accountant's office supplies are not included, but the salary and supplies of the foreman 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 stay the same regardless of the level of production, so per-item costs are reduced if the business 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 business must purchase supplies at $10 each. Each widget sells for $100. After subtracting the manufacturing cost of $10, each widget makes $90 for the business.
To break even, the business must produce 10 widgets every month. It must make more than 10 widgets to become profitable.