How to Calculate Production Cost

by Stephanie Faris ; Updated December 15, 2018
Business Woman Savings Money

For product-based businesses, keeping track of the cost to produce the items you sell is essential. Even the smallest change can free up hundreds or thousands of dollars in your business’ annual budget, and that’s money that can be put toward things like salary increases. But in order to determine the cost of the items you’re manufacturing, you’ll need to first gather information on the actual cost, then perform a calculation to determine the per-unit cost.

Costing Different Products

It’s easier to calculate your production cost if you sell only one product. If your business only sells one kind of mascara and no other products, you can easily determine production costs. However, this isn’t realistic for most businesses. If your business sells mascara, lip glosses in a variety of colors, health supplements and gift sets, you’ll need to take your inventory one SKU at a time and work on determining the production cost of each one. An SKU, or stock keeping unit, is the identifier retailers and other businesses use to track items as they enter and exit inventory. Over time, you’ll be able to compare the cost of each product and put that information to use in improving your bottom line.

For instance, two different colors of lip gloss might be manufactured in different plants, when they could be manufactured in the same plant or outsourced in order to reduce costs. Before you can begin calculating cost, you’ll need to gather all the data on what it takes to make a product. This includes direct costs like materials and employee labor, as well as indirect costs like electricity and equipment wear and tear.

How to Divide Costs

If you only manufacture one item all day, every day, calculating your total manufacturing costs for that product is easier. Simply total up your direct and indirect costs and make your calculation from that. However, if you manufacture multiple products, you’ll need to calculate the cost, then divide it by the number of products. This is where it gets a little complicated. Chances are, you don’t manufacture equal numbers of each product on a regular basis. In that case, you may need to weigh overall operating costs, like rent and employee salaries, by the percentage of time spent manufacturing one product versus another.

For instance, if your primary flagship product is your mascara and your business spends 80 percent of production time on this line, then 80 percent of your electric bill and building expenses will likely be attributed to this product. Perhaps 12 percent of the time is spent manufacturing lip gloss, while the remaining eight percent is allocated to gift sets. Dividing things like utilities, business costs and employee salaries accordingly is important. Otherwise, it looks like your lip gloss is extremely expensive while your mascara has a larger profit margin than expected.

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Calculating Total Per-Unit Cost

Make sure as you gather information on your production costs that you choose a fixed period. Choose an entire calendar year, for instance, or select a specific month. If your production schedule isn’t consistent each month, though, you’ll need to note that as you make your calculation. You may see things slow down after the holidays, for instance, with January being your slowest month of the year. But in October or November, as you ramp up in preparation for the shopping season, you may see your per-unit cost decrease.

The same mascara that costs $2.50 to manufacture in October at high volumes could cost $5 to manufacture in March at much lower volumes. When production is outsourced, some production plants will offer you a set rate for production over the course of a year, taking into account your overall production in a 12 month period. In this case, your manufacturer might offer you a $3.50 production rate, including shipping, over the course of a 12 month period. This can make your calculations easier to arrive at for each individual product offered by your company.

To arrive at the per-unit cost, simply divide the total production cost by the number of units you manufactured during that time period. If the cost varies from one month to the next, calculate this as well, since it helps you compare the revenue you bring in during that time period to what you’re spending.

About the Author

Stephanie Faris is a novelist and business writer whose work has appeared on numerous small business blogs, including Zappos, GoDaddy, 99Designs, and the Intuit Small Business Blog. She worked for the State of Tennessee for 19 years, the latter six of which were spent as a supervisor. She has written about business for entrepreneurs and marketing firms since 2011.

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