Do you see production costs as the one-eyed, runaway monster that keeps you awake at night? If so, you’ve arrived at the right place for help.
Production costs seem to have a mind of their own unless you stay on top of them. For that reason, every business owner finds ways to operate their business efficiently and profitably. To reduce production costs and stay on top of them, managers track expenses to see whether labor, materials, or overhead expenses may exceed budgeted allocations for each phase of production.
2 Key Questions Before Getting Started
Is the product cost the same as the manufacturing cost?
Both of these figures are used to evaluate the total cost of production in a manufacturing business, but they are not the same. Production costs reflect all of the expenses associated with operating and running a business (rent, advertising and marketing, equipment, and supplies). For the most part, these are fixed costs.
On the other hand, manufacturing costs represent only the direct expenses necessary to make the product (materials, labor and overhead). These costs are variable, meaning that they will increase or decrease depending on the changes in production volume.
How do you calculate your cost of production?
You can calculate your total production costs by adding together the fixed costs and the variable costs. To determine the cost of production per unit, divide this sum by the number of units manufactured in the period covered by those costs.
By now, you might be wondering, “How exactly do I keep production costs under control?” and “Can I reduce production costs?”. The secret is to understand what constitutes the cost of production, the types of production costs you’ll encounter, differences between production and manufacturing costs, and ways to keep costs from escalating out of control. And that’s exactly what we are going to cover in this article.
So, let’s get started and knock the proverbial production costs monster in the head, once and for all.
Elements of Production Costs
Monitor the expenditures listed below without sacrificing quality and you’ll be well on your way to improve the overall performance of your business.
Small business owners consider the people who make the production happen as the backbone of their operation. Associated costs include expenses like wages, employee benefits, and payroll taxes. Business owners try to strike a balance between employing the right number of employees and reducing or increasing production levels to realize a profit. You must also calculate expenses incurred to maintain equipment by outside vendors or paid employees.
If, for example, you manufacture a line of furniture, the wood, screws, glue, sandpaper, and other materials you use in construction are raw materials. Likewise, indirect materials would include light bulbs, rags, and other consumables used during the production process.
Equipment used in the cost of production might include forklifts used to load or move raw materials through the production line. Bulldozers, conveyors, and industrial equipment to create textiles or semiconductors are other examples.
In addition to utility costs, energy purchases may include gasoline, oil, or coal to run equipment or heat your facility.
Are you beginning to see that it’s not that hard to track your cost of production? Let’s take a bird’s eye view at additional categories of production costs.
Types of Production Costs
Keeping a close eye on your costs builds confidence in your ability to stay on budget or even keep expenses lower than estimated. You may even be surprised at how quickly your business grows by keeping abreast of costs which increase your cash flow.
These costs stay constant even if production and related expenses increase. In other words, you’ll pay fixed costs every month for the life of your business. Fixed costs include expenditures for insurance, interest, property taxes, and annual salaries. Think of these costs as what you always pay regardless of your level of business activity.
On the other hand, variable costs fluctuate as production increases or decreases. Variable costs are directly related to output. As volume increases so do these expenses. Examples include costs for raw materials, commissions, and labor.
3. Fixed and Variable Combined
As production increases, it’s understandable that constant expenses (like utilities and salaries) as well as variable costs (such as raw materials and other associated supply costs) could increase exponentially. In other words, when production ramps up, your fixed and variable costs may increase.
As you grow your business, the cost structure of your business will evolve. For example, businesses may need to add equipment or lease more production space in an effort to serve more demand. When making these investments, calculate how much volume you need in order to maintain or increase your gross margins and cover all the new fixed costs. In short, keep an eye on your profit margins to ensure your business growth doesn’t put you out of business.
Difference Between Production and Manufacturing Costs
As you’ve already learned, production costs include fixed and variable costs. Fixed costs remain fairly constant while variable costs go up and down depending on production volume.
Manufacturing costs are restricted to the actual costs involved to turn raw materials into a sellable product. Direct costs include the cost of materials, labor costs to produce the specific product, and indirect costs such as factory overhead incurred during the manufacturing process.
Production Costs During the COVID-19 Quarantine
The coronavirus pandemic has affected every single business in the world, but some of the most affected are those that produce products, as most have had to temporarily close and social distancing guides prevent people from being too close to each other.
During these difficult times, your finances might be hurting, and it’s a great idea to cut as many costs as possible during the foreseeable future —things won’t go back to normal for a while, probably until a vaccine is not made available for the general public.
But don’t worry, there are many ways you can reduce your production costs.
10 Ways to Reduce Production Costs
1. Reduce supply costs
Check out new suppliers so you buy quality materials at the best possible wholesale price. Don’t hesitate to ask for an additional discount when you use a certain supplier consistently and always pay them on time. Maybe you can join with another business and purchase materials in larger bulk quantities to reduce costs.
2. Save money on insurance
Insurance companies are notoriously competitive whether you’re shopping for vehicle, liability, or other types of insurance. Work with an insurance broker to review your business insurance needs and have them get you the best rates. You can increase deductibles when possible or secure discounts when installing a security system, fire alarm, or water sprinklers.
3. Modernize marketing efforts with affordable tools
It’s possible to increase sales just by investing a little money in digital marketing. By creating an online presence, potential buyers become familiar with your signature brand and become interested in your business. And this shouldn’t cost you a leg and an arm if you choose the right platforms. Remember that most social platforms are free.
4. Visit your accountant
Check in with a professional accountant yearly, if not more often, to make sure you are listing allowable business expenses so you can take advantage of every business tax deduction. It’s important to keep receipts in a safe place such as a secure binder and to record vehicle mileage as you travel between locations.
5. Optimize use of technology
Cheap and free management software is available to manage inventory, sales, employee, and sales information. Other technologies you’ll want to investigate are security, private networking, and software to store business data. By availing yourself to technology, you free up time for advertising and marketing along with reducing personal stress.
6. Optimize space
If you rent space, there’s no reason you can’t negotiate lease terms with the landlord. Depending on zoning requirements, it may be possible to operate a portion of your business from your home to save costs on rent, utilities, and insurance.
7. Maximize employees’ skills
Happy employees translate to increased performance with less chance of a turnover. Increase vacation and other paid leave, offer a retirement plan, or use a performance management system to increase productivity.
8. Prioritize quality over quantity
Keeping a large inventory of less-than-stellar products does nothing toward sustained sales and longevity. Buyers keep coming back because superior products always win out over the competition.
9. Reduce vehicle expenses
New vehicles depreciate as soon as they leave the premises. Buying used vehicles in good working order can save you thousands not to mention lower insurance premiums. Fuel-efficient vehicles save you money and are generally more maintenance-free. Some business owners lease a vehicle for a set amount of time. It’s up to you whether you lease another vehicle at the end of the term or decide to purchase the vehicle.
10. Keep production costs on a spreadsheet
Update all your production costs on a regular basis so you know at a glance exactly what you’re spending and analyze the data. Once you insert formulas into your spreadsheet, the document does all the computations as you input new data monthly.
Now that you’ve learned the significance of getting a handle on costs, you can enjoy the perks of streamlining your day-to-day operation.
Benefits of Reducing Production Costs
You’ve acquired valuable information to keep your business healthy and prosperous. Knowing your cost of production and keeping it lean means you eliminate unnecessary wasteful activities and purchases resulting in maximized cost reductions. Essentially, that equates to more money in the bank to expand your operation even further or create a nest egg for unforeseen expenses.
You could also pass on your cost savings to your customers to further increase the demand for products. Moreover, sharing your prosperity in the form of staff bonuses or getaways contributes to improved employee-employer relationships.
You may even have money left over for research and development for your next big seller that goes viral. By implementing these suggestions on how to reduce production costs, you’re well on your way to achieve every goal on your business plan.
By now you should have a better idea of how to monitor and reduce your production costs. And remember that whatever way you decide to reduce production and other related costs, we can help.
Camino Financial is here to come alongside your business whether you glean helpful tips from our newsletter, apply for a small business loan, or need advice on how to manage your business. Our company provides help by way of tools, resources, and advice to increase your profits and grow your business. Why not connect with us as soon as possible and take your business plan from dreams on paper to full-blown reality!