# Costs of production

Costs of production

Production costs include costs that are directly related to the product or are indirectly related to the product. They create value, they are closely related to the technological process of manufacturing services and products.

Production costs can be divided into: direct costs, which include: value of used direct materials, acquisition and processing costs, other costs incurred, which are related to the delivery of the product to the place and condition in which it is on the valuation date and indirect costs, i.e. : variable indirect production costs and part of fixed production costs.

Each company aims to generate profit. Very often, a strategy to reduce costs is used to increase profit. They are an unavoidable phenomenon that arises during production because the production of goods requires a lot of materials or work from the entrepreneur. Many activities related to the reduction of costs concern the technical side of production processes, e.g. using cheaper materials or changing technology. Cost analysis allows, among others recognizing where they are generated, calculating how much it costs to produce a certain amount of goods, and also gives an answer to the question how to reduce production costs?

## Optimization

To find the "golden mean" of the company, they strive for optimization. You can find it in a function where one variable is the amount of goods produced and the other the production costs. If it is a linear function, the search for optimum has no purpose, because every solution is correct. However, if the function has a form other than linear, we can expect that only one or at most several combinations of factors of production allows for production at the lowest cost in a given production system. Finding such a solution may turn out to be very beneficial for the company.

## The cost of producing the product

The total cost of production of a product consists of many elements, the overall size of which changes directly in proportion to the number of manufactured products of a given type. These components are called variable costs.

Variable indirect product costs are costs that have been incurred during the manufacture of the product, which are directly or almost directly dependent on the production volume or change with the change of other relevant factors, i.e. the number of hours of production equipment or the number of production batches produced.

Variable costs - these are costs depending on the volume of production, for example,

• Wages of production workers
• costs of raw materials, materials and semi-finished products
• costs of energy and water consumption
• transport costs

The components included in the group of fixed costs, the size of which does not depend on the size of production, behave differently.

Permanent indirect product costs are costs incurred during production of the product, which remain unchanged, and remain independent of the production volume and size of other factors such as the number of hours of equipment and machinery or the number of production batches produced. For example, you can include depreciation costs and management costs. Fixed production costs are assigned to each unit of the product in an amount corresponding to the level of costs calculated on the product unit using the production capacity. Fixed indirect costs of production affect the financial result of the reporting period in which they arose.

Fixed costs - these are costs independent of the production volume, for fixed costs, e.g.:

• Costs of land use, renting premises
• Wages of administration employees and their insurance
• costs of building and equipment wear
• loan costs and some taxes
• depreciation

## The law of diminishing revenues

This law determines the relationship between inputs of production factors and the amount of product produced. When increasing one factor causes decreasing production increases, we are dealing with the law of diminishing marginal revenues. Its operation is explained by a decreasing amount of a fixed factor per each unit of variable factor. This law only works in a short period, when it is possible to change the amount of one of the production factors with the other invariant factors.

## Cost analysis

Analysis of direct costs Various methods of cause and effect analysis are used here. One of the most popular methods is the method of subsequent substitutions, which consists in the subsequent substitution of a specific factor in the size of the actual size actually made and the calculation of the difference between them. Such a calculation makes it possible to determine the impact of a given factor on the level of costs.

Analysis of indirect costs These costs vary in nature and therefore each type of these costs requires a separate analytical approach. Indirect fixed costs are analyzed for individual responsibility centers in the plan-execution relationship, while those components of indirect costs which depend on the production volume - variable costs (e.g. within faculty costs) are analyzed in a similar way to the analysis of direct costs.

## Benefits and disadvantages of the production scale

• Benefits of production scale - we deal with them when long-term average total costs decrease with increasing production volume.
• Disadvantages of the production scale - they are when the long-term average total costs increase with the increase in production volume.
• Constant revenues of the production scale - when long-term average total costs do not change with the increase of production volume.