How to Calculate Total Production Cost

Total production cost represents the complete sum of money a business expends on resources and operations to manufacture a finished product. This calculation is a fundamental aspect of financial management, providing insights into operational efficiency and informing strategic decisions like product pricing. Accurately determining this cost helps a company understand the true expense of bringing goods to market.

Understanding Production Cost Components

The total production cost is comprised of three main elements: direct materials, direct labor, and manufacturing overhead. Each component accounts for different types of expenses incurred during the manufacturing process. Businesses need a clear understanding of these building blocks to accurately assess their production expenses.

Direct materials

Direct materials are the raw materials and components that physically become part of the finished product and can be directly traced to specific units of production. For instance, in furniture manufacturing, wood planks, screws, bolts, and fabric for upholstery are direct materials. For a bakery, flour, yeast, sugar, and oil used to make bread are direct materials. Packaging materials can also be considered direct materials if they are directly traceable to each product unit, such as boxes for cereal.

Direct labor

Direct labor refers to the wages, salaries, and benefits paid to employees who are directly involved in the manufacturing or assembly process. Examples include assembly line workers, machine operators, and craftspeople.

Manufacturing overhead

Manufacturing overhead includes all indirect costs associated with the production process that are not direct materials or direct labor. These costs are necessary for production but cannot be easily traced to individual units. Common examples of manufacturing overhead include indirect materials (like lubricants or cleaning supplies), indirect labor (such as factory supervisors or maintenance staff), factory rent, utilities, depreciation of factory equipment, and factory insurance.

Classifying Production Costs

Understanding the behavior of production costs by classifying them as fixed or variable is important for financial planning and decision-making. This classification helps businesses predict how total costs will change with varying production levels.

Fixed costs

Fixed costs are expenses that do not change in total, regardless of the volume of goods produced, within a relevant range of activity. These costs are incurred even if no production occurs. Examples of fixed costs in a manufacturing setting include factory rent, straight-line depreciation on machinery, factory insurance premiums, and the salaries of production managers or supervisors.

Variable costs

Variable costs are expenses that change in direct proportion to the level of production output. As more units are produced, the total variable costs increase, and conversely, they decrease with lower production volumes. Direct materials and direct labor are typically variable costs because their consumption is directly tied to the number of units manufactured. Other examples of variable costs include utilities tied directly to machine usage, such as electricity consumed by production machinery, and production-based commissions. This distinction is valuable for assessing profitability and making informed decisions about production levels and pricing strategies.

Steps to Calculate Total Production Cost

Calculating the total production cost involves systematically gathering and summing the costs from each component over a specific period. This process brings together the defined cost elements to provide a comprehensive financial metric.

Step 1: Direct Materials

The first step is to identify and sum the total cost of all direct materials consumed during the production period. This involves accounting for any beginning inventory of raw materials, adding the cost of new materials purchased, and then subtracting the cost of any ending raw materials inventory. For example, if a company started with $10,000 in raw materials, purchased an additional $50,000, and had $8,000 remaining, the direct materials cost would be $52,000.

Step 2: Direct Labor

The second step requires identifying and summing the total direct labor cost incurred for the same production period. This includes the wages, salaries, and benefits paid to all employees directly involved in the manufacturing process. For instance, if production line workers collectively earned $30,000 in wages and $5,000 in benefits and payroll taxes for the period, the direct labor cost would be $35,000.

Step 3: Manufacturing Overhead

The third step involves identifying and summing all manufacturing overhead costs for the period. This includes all indirect production expenses, such as indirect materials, indirect labor (e.g., supervisor salaries, maintenance staff wages), factory utilities, depreciation on factory equipment, and factory rent. For example, if indirect materials totaled $2,000, indirect labor $8,000, factory rent $4,000, utilities $1,500, and depreciation $3,500, the total manufacturing overhead would be $19,000.

Formula

Once these three components are determined, the total production cost is calculated using a straightforward formula: Total Production Cost = Direct Materials + Direct Labor + Manufacturing Overhead. Using the hypothetical figures above, the total production cost would be $52,000 (Direct Materials) + $35,000 (Direct Labor) + $19,000 (Manufacturing Overhead), resulting in a total production cost of $106,000 for the period.