Why cost your product?
How else would you know what prices to charge in selling your products? How else would you know how much working capital to have in hand to keep your production going? Perhaps, most importantly, you should know your product cost in order to make a continuing effort to reduce cost of production and hence improve your competitiveness in the market and ultimately increase profitability.
Here are fundamentals of product costing for the newbie entrepreneur:
The cost of a product is made up of three parts: direct materials, direct labor, and manufacturing overhead.
Direct materials are inputs that become part of the product. Examples are the the milk and sugar used to make pastillas or ice cream; the leather used in making shoes and handbags; or the precious stones used in crafting earrings, necklaces and other jewelry.
Direct labor includes the workers whose outputs are closely related or associated with the making of product. From the same examples gtiven, direct labor is provided by the worker who prepares and mixes the ingredients for the ice cream as well as those of the shoemaker, and the mounter who sets the stone on jewelry.
Manufacturing overhead comprises all other costs incurred in production, but do not become part of the product. These include:
- The use of the buildings, machines, and equipment and their maintenance
- Utilities such as power, water, and fuel used to keep the factory running
- Salaries of all employees not directly involved in making the product. These include salaries of the production foreman, the clerk, and security guard.
- Transport costs of raw materials
- Office supplies and expenses such as paper, telephone, photocopying, etc.
Expenses are classified either as fixed or variable.
Fixed expenses are costs that continue even if no units are produced. Examples include equipment depreciation, taxes, interests on debts, and rental payments.
Variable expenses are those that vary with the volume of units produced. The major components of variable costs are labor and materials. However, other costs, such as the portion of the utilities that vary with the volume, are also variable cost. The difference between selling price and variable cost is contribution. Only when total contribution exceeds total fixed cost will there be profit.
The entrepreneur/production manager should not only strive constantly to cut production costs but should also promote the workers’ awareness of the advantages and benefits of keeping production costs to the minimum level.