What Are Production Costs?
Production costs refer to all of the direct and indirect costs businesses face
from manufacturing a product or providing a service. Production costs can
include a variety of expenses, such as labor, raw materials
(https://www.investopedia.com/terms/r/rawmaterials.asp), consumable
manufacturing supplies, and general overhead
(https://www.investopedia.com/ask/answers/101314/what-are-differencesbetween-operating-expenses-and-overhead-expenses.asp).
OF CONTENTS
CORPORATE FINANCE (https://www.investopedia.com/corporate-finance-andaccounting-4689821)
ACCOUNTING (https://www.investopedia.com/accounting-4689820)
Production Costs: What They Are and How to Calculate Them
By
ADAM HAYES (https://www.investopedia.com/contributors/53677/)
Updated June 29, 2022
Reviewed by
DAVID KINDNESS (https://www.investopedia.com/david-kindness-4799933)
Fact checked by
KATRINA MUNICHIELLO (https://www.investopedia.com/katrina-munichiello5078531)

Investopedia / Crea Taylor
What Are Production Costs?
Production costs refer to all of the direct and indirect costs businesses face
from manufacturing a product or providing a service. Production costs can
include a variety of expenses, such as labor, raw materials
(https://www.investopedia.com/terms/r/rawmaterials.asp), consumable
manufacturing supplies, and general overhead
(https://www.investopedia.com/ask/answers/101314/what-are-differencesbetween-operating-expenses-and-overhead-expenses.asp).
KEY TAKEAWAYS
Production costs refer to the costs a company incurs from manufacturing a
product or providing a service that generates revenue for the company.
Production costs can include a variety of expenses, such as labor, raw
materials, consumable manufacturing supplies, and general overhead.
Total product costs can be determined by adding together the total direct
materials and labor costs as well as the total manufacturing overhead costs.
Understanding Production Costs
Production costs, which are also known as product costs, are incurred by a
business when it manufactures a product or provides a service. These costs
include a variety of expenses. For example, manufacturers have production
costs related to the raw materials and labor needed to create the product.
Service industries incur production costs related to the labor required to
implement the service and any costs of materials involved in delivering the
service.1
Taxes levied by the government or royalties owed by natural resourceextraction companies are also treated as production costs.1 Once a product is
finished, the company records the product's value as an asset in its financial
statements (https://www.investopedia.com/terms/f/financial-statements.asp)
until the product is sold. Recording a finished product as an asset serves to
fulfill the company's reporting requirements and inform shareholders
(https://www.investopedia.com/terms/s/shareholder.as
Total product costs can be determined by adding together the total direct
materials and labor costs as well as the total manufacturing overhead costs.1
Data like the cost of production per unit can help a business set an appropriate
sales price for the finished item.
To arrive at the cost of production per unit, production costs are divided by the
number of units manufactured in the period covered by those costs. To break
even, the sales price must cover the cost per unit. Prices that are greater than
the cost per unit result in profits, whereas prices that are less than the cost per
unit result in losses.1
Types of Production Costs
Production incurs both fixed costs and variable costs
(https://www.investopedia.com/terms/v/variablecost.asp). For example, fixed
costs for manufacturing an automobile would include equipment as well as
workers' salaries. As the rate of production increases, fixed costs remain
steady.1
Variable costs increase or decrease as production volume changes. Utility
expenses are a prime example of a variable cost, as more energy is generally
needed as production scales up.1
The marginal cost of production
(https://www.investopedia.com/terms/m/marginalcostofproduction.asp)
refers to the total cost to produce one additional unit. In economic theory, a
firm will continue to expand the production of a good until its marginal cost of
production is equal to its marginal product (marginal revenue
(https://www.investopedia.com/ask/answers/041315/how-marginal-revenuerelated-marginal-cost-production.asp)). This, in turn, will tend to equal its
selling price.
Special Considerations
There may be options available to producers if the cost of production exceeds
a product's sale price. The first thing they may consider doing is lowering their
production costs (https://www.investopedia.com/terms/v/valueengineering.asp). If this isn't feasible, they may need to reconsider their pricing
structure and marketing strategy to determine if they can justify a price
increase or if they can market the product to a new demographic. If neither of
these options works, producers may have to suspend their operations or shut
down permanently.1
Here's a hypothetical example to show how this works using the price of oil.
Let's say oil prices dropped to $45 a barrel. If production costs varied between
$20 and $50 per barrel, then a cash-negative situation would occur for
producers with steep production costs. These companies could choose to stop
production until sale prices returned to profitable levels.
How Are Production Costs Determined?
For an expense to qualify as a production cost it must be directly connected to
generating revenue for the company. Manufacturers carry production costs
related to the raw materials and labor needed to create their products. Service
industries carry production costs related to the labor required to implement
and deliver their service. Royalties owed by natural resource-extraction
companies also are treated as production costs, as are taxes levied by the
government.
How Are Production Costs Calculated?
Production incurs both direct costs
(https://www.investopedia.com/terms/d/directcost.asp) and indirect costs.
Direct costs for manufacturing an automobile, for example, would be materials
like plastic and metal, as well as workers' salaries. Indirect costs would include
overhead such as rent and utility expenses. Total product costs can be
determined by adding together the total direct materials and labor costs as
well as the total manufacturing overhead costs. To determine the product cost
per unit of product, divide this sum by the number of units manufactured in
the period covered by those costs.1
How Does Production Costs Differ From Manufacturing Costs?
Production cost refers to all of the expenses associated with a company
conducting its business while manufacturing cost represents only the expenses
necessary to make the product. Whereas production costs include both direct
and indirect costs of operating a business, manufacturing costs reflect only
direct costs.
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What Are the Different International Trade Theories?
“Around 5,200 years ago, Uruk, in southern Mesopotamia, was probably
the first city the world had ever seen, housing more than 50,000 people
within its six miles of wall. Uruk, its agriculture made prosperous by
sophisticated irrigation canals, was home to the first class of middlemen,
trade intermediaries…A cooperative trade network…set the pattern that
would endure for the next 6,000 years.”Matt Ridley, “Humans: Why They
Triumphed,” Wall Street Journal, May 22, 2010, accessed December 20,
2010,
International trade theories are simply different theories to explain
international trade. Trade is the concept of exchanging goods and
services between two people or entities. International trade is then the
concept of this exchange between people or entities in two different
countries.
People or entities trade because they believe that they benefit from the
exchange. They may need or want the goods or services. While at the
surface, this many sound very simple, there is a great deal of theory,
policy, and business strategy that constitutes international trade.
In this section, you’ll learn about the different trade theories that have
evolved over the past century and which are most relevant today.
Additionally, you’ll explore the factors that impact international trade
and how businesses and governments use these factors to their
respective benefits to promote their interests.
international trade, economic transactions that are made between
countries. Among the items commonly traded are consumer goods, such
as television sets and clothing; capital goods, such as machinery; and raw
materials and food. Other transactions involve services, such as travel
services and payments for foreign patents (see service industry
(https://www.britannica.com/topic/service-industry)). International trade
transactions are facilitated (https://www.merriamwebster.com/dictionary/facilitated) by international financial payments,
in which the private banking system and the central banks
(https://www.britannica.com/topic/central-bank) of the trading nations
play important roles
exchanges, dedicated to teaching courses such as "International Trade
Theory and Practice", "International Economics" and "Economics" for
international masters and undergraduates.
Engaging in international trade and environmental management
research, he has published many papers as the first author in this field,
including 10 SSCI/SCI, as well as 1 monograph and 1 key textbook of
Jiangsu Province. Meanwhile, he presided over a number of projects,
involving 2 general projects of the National Social Science Foundation, 1
key project of Philosophy and Social Science in Jiangsu Province, 1
project of the Humanities and Social Science Research Youth Project of
the Ministry of Education, and 1 Youth of the Jiangsu Provincial Social
Science Foundation project.
Cash flow from investing activities (CFI) is one of the sections on the cash
flow statement that reports how much cash has been generated or spent
from various investment-related activities in a specific period. Investing
activities include purchases of physical assets, investments in securities,
or the sale of securities or assets.
Negative cash flow is often indicative of a company's poor performance.
However, negative cash flow from investing activities might be due to
significant amounts of cash being invested in the long-term health of the
company, such as research and development.
Cash flow from investing activities is a section of the cash flow statement
that shows the cash generated or spent relating to investment activities.
Investing activities include purchases of physical assets, investments in
securities, or the sale of securities or assets.
Negative cash flow from investing activities might not be a bad sign if
management is investing in the long-term health of the company
Understanding Cash Flow From Investing Activities
Before analyzing the different types of positive and negative cash flows
from investing activities, it's important to review where a company's
investment activity falls within its financial statements. There are three
main financial statements: the balance sheet, income statement, and
cash flow statement.
The balance sheet provides an overview of a company's assets, liabilities,
and owner's equity as of a specific date. The income statement provides
an overview of company revenues and expenses during a period. The
cash flow statement bridges the gap between the income statement and
the balance sheet by showing how much cash is generated or spent on
operating, investing, and financing activities for a specific period.
Types of Cash Flow
Overall, the cash flow statement provides an account of the cash used in
operations, including working capital
(https://www.investopedia.com/terms/w/workingcapital.asp), financing,
and investing. There are three sections–labeled activities–on the cash
flow statement.
Cash Flow From Operating
Operating activities include any spending or sources of cash that are
involved in a company's day-to-day business activities.
What are Imports and Exports?
Imports are the goods and services that are purchased from the rest of the
world by a country’s residents, rather than buying domestically produced
items. Imports lead to an outflow of funds from the country since import
transactions involve payments to sellers residing in another country.
Exports are goods and services that are produced domestically, but then sold
to customers residing in other countries. Exports lead to an inflow of funds to
the seller’s country since export transactions involve selling domestic goods
and services to foreign buyers.
What is Gross Domestic Product (GDP)?
Gross Domestic Product (GDP) is the gross market value of the total goods and
services
(https://corporatefinanceinstitute.com/resources/knowledge/other/productsand-services/) produced within the domestic boundaries of a country during a
given period of time. It is also known as National Income (Y). Total imports and
total exports are essential components for the estimation of a country’s GDP.
They are taken into account as “Net Exports”.
GDP = C + I + G + X – M
Where:
C = Consumer expenditure
I = Investment expenditure
G = Government expenditure
X = Total exports
M = Total imports
Net Exports
(X-M) in the above equation represents net exports. Net exports are the
estimation of the total value of a country’s exports minus the total value of its
imports. A positive net exports figure indicates a trade surplus.
On the other hand, a negative net exports figure indicates a trade deficit. A
trade surplus or trade deficit reflects a country’s balance of trade
(https://corporatefinanceinstitute.com/resources/knowledge/economics/bala
nce-of-trade-bot/) (which is, essentially, whether a country is a net exporter or
importer, and to what extent).
How to Decrease Imports/Increase Exports
1. Taxes and quotas
Governments decrease excessive import activity by imposing tariffs
(https://corporatefinanceinstitute.com/resources/knowledge/other/tariff/)
and quotas on imports. The tariffs make importing goods and services more
expensive than purchasing them domestically. Imposing tariffs is one way a
country can work to improve its balance of trade.
2. Subsidies
Governments provide subsidies to domestic businesses in order to reduce their
business costs. This helps bring down the price of domestic goods and services,
(https://corporatefinanceinstitute.com/resources/knowledge/other/productsand-services/) hopefully, encouraging consumers to buy domestic rather than
imported goods. By enabling domestic producers to produce goods less
expensively and, thus, lower their prices, subsidies may also increase exports
as the cheaper goods become more attractive to foreign buyers.
Quality of goods must still be factored into the equation. If consumers are
convinced that a certain product made in country “X” is of substantially better
quality than the same product as made in country “Y”, then they may continue
purchasing the product from manufacturers in country “X” even if government
subsidies to manufacturers in country “Y” have made it significantly less
expensive to buy from country “Y”.
An example of the quality issue is illustrated by Sony televisions, which are
perceived by many consumers as being of notably superior quality to other
brands. Therefore, despite the fact that Sony TVs carry a significantly higher
price tag, they still outsell many other brands because consumers are willing to
pay more for superior quality.
A good example of quality perception affecting imports/exports can be drawn
from the wine industry. For years, wineries in the United States experienced
difficulties even selling their products domestically, largely because of the fact
that U.S. wines were not considered to be of the same quality as, say, French
or Italian wines.
However, as the quality of U.S. vintages improved and became acknowledged
in the marketplace, sales by U.S. wineries not only reduced imports of foreign
wines – but also began to develop a sizable export business as many European
consumers began buying wines produced in the States.
3. Trade agreements
Sometimes, countries ensure a regular flow of international trade, i.e., a high
volume of both imports and exports, by entering into a trade agreement with
another country. Such agreements are aimed at stimulating trade and
supporting economic growth for both countries involved.
Trade agreements typically focus on the exchange of different types of
products. For example, the U.S. might enter into a trade agreement with Japan
where Japan agrees to buy a certain amount of American-made automobiles
(https://www.selectusa.gov/automotive-industry-unitedstates#:~:text=The%20United%20States%20has%20one,or%20surpassed%201
7%20million%20units.&text=Total%20foreign%20direct%20investment%20in,r
eached%20%24114.6%20billion%20in%202018.) in exchange for the U.S.
increasing its imports of Japanese rice.
4. Currency devaluation
Another method of increasing exports and decreasing imports is by devaluing
the domestic currency. Governments devalue their currency with the aim of
bringing down the prices of domestic goods and services, the ultimate goal
being to increase net exports. The currency devaluation also makes purchasing
from other countries more expensive, thus discouraging imports.
How Important are Imports and Exports?
Countries vary considerably with regard to how important imports and
exports, and their overall balance of trade is to their economies. For China, the
world’s largest exporting country, exports and a net positive balance of trade
are critical to the success and growth of the country’s economy. Maintaining a
high level of exports is also very important to the economies of the U.K. and
Australia.
The growth of economies of developing countries is often fueled by massive
exports of commodities and raw materials to developed nations. For this
reason, mining is commonly a key industry in such countries.
Related Readings
Thank you for reading CFI’s guide to Imports and Exports. To keep advancing
your career, the additional CFI resources below will be useful:
Aggregate Supply and Demand
(https://corporatefinanceinstitute.com/resources/knowledge/economics/aggr
egate-supply-demand/)
Balance of Payments
(https://corporatefinanceinstitute.com/resources/knowledge/economics/bala
nce-of-payments/)
Consumer Surplus Formula
(https://corporatefinanceinstitute.com/resources/knowledge/economics/cons
umer-surplus-formula/)
Gross National Product
(https://corporatefinanceinstitute.com/resources/knowledge/economics/gros
s-national-product-gnp/)
See all economics resources
(https://corporatefinanceinstitute.com/topic/economics/)