Production costs vs. manufacturing costs: what’s the difference, and why do they matter?
It’s a great question for accountants working towards providing manufacturing companies with indispensable services because the truth is, these cost numbers can tell you a lot about your client’s business.
Let’s jump right in.
Production costs are the expenses a company generates throughout the entire process of creating and distributing a product or service.
While production costs vary based on the industry and product being produced, there are a few common elements across the board:
Notice that production costs include both variable and fixed costs. By understanding and managing production costs, companies can optimize their:
Because production costs encompass the entire process of creating and distributing a product or service, there are a variety of factors that impact them. Some of these factors include:
Let’s dive a little deeper into some of the more impactful factors.
In many cases, as production costs decrease, the volume of production increases. This is known as the economies of scale. With larger productions quantities, companies can:
The price and availability of raw materials, components, and other inputs needed for production have a significant impact on production costs.
For example, if a company requires a specific type of plastic to produce the product, but the cost of the plastic has doubled compared to last year, the company's production costs will be impacted.
The efficiency of production methods can greatly affect the production costs. To optimize these, companies can:
Paying close attention to these influential factors will help you control production costs, improve competitiveness, and maximize profitability.
Unlike production costs, manufacturing costs only focus on the costs associated with the production phase. For most companies, this includes:
Each of these costs focuses on the direct costs involved in converting raw materials into finished goods. It’s important to note that manufacturing costs do not include non-productions costs like research and development expenses, marketing costs, sales commissions, administrative costs, or distribution costs. Instead, these would fall into the category of indirect costs.
By understanding and managing manufacturing costs, companies can:
There are several factors that influence manufacturing costs, and they can vary based on industry, production methods, scale of operations, and location. Some of the factors include:
Let’s take a closer look at some of the more impactful factors.
The complexity and design of a product can significantly impact manufacturing costs. some of these influences include:
The production volume can be impacted through economies of scale (which we explained previously).
In many cases, higher production volumes lead to lower per-unit costs as fixed costs are spread out over a larger number of units. Inversely, lower production volumes can result in higher per-unit costs due to reduced efficiency and economies of scale.
The cost and availability of raw materials and components required for manufacturing directly impact manufacturing costs. This happens when there are:
When you pay close attention to these influential factors, you can identify opportunities for cost reduction and operational improvement.
Throughout the article, we’ve mentioned some of the reasons why it’s important to analyze production costs and manufacturing costs, but it’s important we dive a little deeper to help you understand exactly how these numbers can impact the companies you are working with.
The list of reasons goes on, but the bottom line is you need accurate production and manufacturing cost numbers to help your clients make strategic decisions that move their company forward.