There are many sorts of expenses a company has to incur in the course of its work. The product costs are the most common (and often the biggest) source of expenditures. They unite all the expense accounts needed to complete a unit of production (either a product or a service).
The production needs a lot of things to sustain its operation:
- Materials for products
- Salaries for workers who end up creating a product/providing a service
- Expenditures that don’t have much to do with the creation process itself, but are still necessary to complete production.
These are direct (the first two) and indirect (the last) costs of production. The indirect expenditures can largely be united into a group called overhead, and it basically includes everything that keeps the facility operational without directly contributing to the process of assembling a product.
What are Product Costs?
When the business has to compile financial statements for each month, they’ll have to mention just how much of their expenses are production costs. Although important for accounting and investors, these numbers are also crucial for the producer itself. Understanding how much you pay for stuff is the first step to reducing your expenses.
- Direct costs
Direct costs are those expenses associated directly with the production process. It usually includes paying for the raw materials and paying your employees to make these materials into a product. With services, it’s even simpler – you only need to account for the pay workers get (those who directly provide services).
There isn’t anything besides that, the boundaries are clear. If you know that the cost you’re paying for something is absolutely necessary for the product to be completed, it’s still not a direct cost unless it’s payment for something that takes material and makes it a final product.
Meat, vegetables, buns, oil, spices, and cook salary – are all direct costs for a burger joint operation
- Indirect costs
In the course of the business’ operation, it has to spend money so that the products continue being created. These don’t have much to do with the process itself, but they make it possible. Basically, most of the operating expenditures excluding the direct costs in the business are indirect costs.
The most common example is indirect labor wages. There are lots of workstations that contribute to the product’s quality, ease of creation or safety, which are indirect costs. Alternatively, there are indirect material expenses – they all contribute to the workers being able to do their job well.
Most of these expenses are unclassified. Rent and utilities are classic examples of something that makes product creation possible but still doesn’t necessarily participate in the process itself.
Janitor wages, manager wages, repairman wages, coffee, furnishing, utilities, depreciation, and other costs are the usual examples of indirect costs for a burger joint.
Why account for them?
Simply put, accounting is just the recording of any little tidbits about the company’s financial status. Everything that happens during a month and involves money has to be taken into account. Otherwise, you won’t know where the money went and how to avoid it in the future.
The production costs should be present in every Income statement, according to international standards. It is partially done so that investors and other parties could keep the companies in check and monitor their wellbeing.
However, it’s also incredibly important for the business. If you divide your overall costs among different accounts and analyze the same accounts each month, you’ll see which of these costs are not essential, irrational, or growing. Then, it’ll be very easy to reduce costs reasonably and therefore benefit everyone.
That being said, you can’t always just decrease production costs and expect the products to retain their quality. Although it’s a common practice to just cut the corners and thus save on product costs, it’s also possible to save money while keeping the manufacturing costs as they are.
Non-operating income and costs are those expenses and gains that have absolutely nothing to do with manufacturing or provision of services. These are investments, marketing, or perhaps research (although this one is disputable). Rethinking your strategy in these fields can also benefit the company’s financial situation.
It’s generally helpful to take the same approach to most financial accounts as you do with the manufacturing costs because it’ll help you manage expenses and gains in a much better way.