The cost to prepare a machine or process for production refers to the total costs that are incurred when producing a product, such as the cost of machinery, the cost to operate the machinery and every process involved. This production cost may include things such as labour, raw materials, or consumable supplies.
In economics, the cost of production is defined as the expenditure incurred to obtain the factors of production such as labour, land, and capital, that are needed in the production process. However, for an expense to qualify as a production cost it is expected to be directly connected to generating revenue for the company.
Note that manufacturers tend to carry production costs related to the raw materials and labour needed to create the product. Service industries carry production costs related to the labour required to implement the service and any material costs involved in delivering the service.
Production incurs both direct costs and indirect costs. Direct cost for producing an automobile, for instance, would be materials like plastic and metal, as well as workers’ salaries. While indirect costs may include things like: Indirect materials which are materials used in the production process but that are not directly traceable to the product. Glue, oil, tape, cleaning supplies, etc. are classified as indirect materials.
And indirect labour refers to the labour of those who are not directly involved in the production of the products. An example would be security guards, supervisors, and quality assurance workers in the factory. Their wages and benefits would be classified as indirect labour costs.
Types of Costs Incurred When Preparing a Machine or Process for Production
There are various types of costs that businesses may incur in the course of offering a service. They include the following:
Fixed costs are expenses that do not change with the amount of output produced. It simply means that the costs remain unchanged even when there is zero production or when the business has reached its maximum production capacity. For instance, a shoe making business is expected to pay its monthly, quarterly, or yearly rent regardless of the number of customers it serves.
Other examples of fixed costs include salaries and equipment leases. Have it in mind that fixed costs tend to be time-limited, and they are only fixed in relation to the production for a certain period. In the long term, the cost of producing a product are variable and will change from one period to another.
The average cost simply means the total cost of production divided by the number of units produced. It can also be obtained by summing the average variable costs and the average fixed costs. Management uses average costs to make decisions pricing its products for maximum revenue or profit. The aim of the company should be to minimize the average cost per unit so that it can increase the profit margin without increasing costs.
Variable costs are costs that change with the changes in the level of production. They rise as the production volume increases and decrease as the production volume decreases. If the production volume is zero, then no variable costs are incurred. Examples of variable costs include sales commissions, utility costs, raw materials, and direct labour costs.
For instance, in a shoemaking facility, the variable costs may include raw materials used in the production process and direct labour costs. If the raw materials and direct labour costs incurred in the production of shoes are $7 per unit and the company produces 1000 units, then the total variable costs are $7,000.
Total cost is made up of both variable and fixed costs. It takes into account all the costs incurred in the production process or when offering a service. For instance, assume that a shoe making company incurs a production cost of $7 per shoe, and it produced 1,000 units during the last month. The company also pays a rent of $1,500 per month. The total cost includes the variable cost of $7,000 ($7 x 1,000) and a fixed cost of $1,500 per month, bringing the total cost to $8,500.
Marginal cost refers to the cost of producing one additional unit of output. It shows the increase in total cost coming from the production of one more product unit. Since fixed costs remain constant irrespective of any increase in output, marginal cost is primarily affected by changes in variable costs. The management of a company tend to rely on marginal costing to make decisions on resource allocation, looking to allocate production resources in a way that is optimally profitable.
For instance, if a Shoemaking Company wants to increase production capacity, it will compare the marginal cost vis-à-vis the marginal revenue that will be realized by producing one more unit of output. Marginal costs also tend to vary with the volume of output being produced. They are affected by various factors, such as price discrimination, externalities, information asymmetry, and transaction costs.
Note that the very first step when calculating the cost involved in preparing a machine or process of production is to determine the fixed costs. The next step is to determine the variable costs incurred in the production process. Then, add the fixed costs and variable costs, and divide the total cost by the number of items produced to get the average cost per unit.
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