Understanding the Difference Between Cost of Production (HPP) and Cost of Goods Sold (COGS)

In the business world, understanding operational costs is crucial, especially when calculating profits.

Two terms that often arise are Cost of Production (HPP) and Cost of Goods Sold (COGS). Although they may sound similar, they have fundamental differences that affect how businesses record and analyze costs.

This time, ESB will thoroughly explain the differences between the cost of production and the cost of goods sold as follows:

What is the Cost of Production (HPP)?

The Cost of Production (HPP) refers to expenses directly related to the process of producing goods. These costs include:

• Direct Raw Materials: Ingredients (such as vegetables, meat, flour, spices) and packaging materials (like plastic or takeaway boxes).
• Direct Labor: Salaries or wages of workers directly involved in food preparation, such as chefs or waitstaff.
• Production Overhead: Costs like kitchen electricity, depreciation of kitchen equipment (ovens, blenders, etc.), and maintenance of cooking tools.

How to Calculate Cost of Production:

For example, a toy company records the cost of plastic materials and factory workers' wages as Cost of Production

What is Cost of Goods Sold (COGS)?

Cost of Goods Sold (COGS) refers to the expenses directly associated with producing goods sold or services provided.

In the culinary business, COGS covers a broader scope since it includes not only raw materials but also various other costs, such as:

• Raw Materials:
  • Main ingredients like meat, fish, vegetables, or spices.
  • Additional costs like seasoning, oil, and complementary materials.

• Direct Labor Costs:
  • Salaries for chefs and kitchen staff directly involved in the cooking process.
• Supporting Operational Costs:
  • Gas or electricity used for cooking
  • Water costs for cleaning raw materials and cooking equipment.
• Service Costs (if applicable):
  • Packaging costs for food delivery services
  • Additional service costs, such as delivery to customers.
• Marketing and Administrative Costs:
  • Costs related to promoting the business or managing its operations.

How to Calculate Cost of Production:

For example, a toy company records the cost of plastic materials and factory workers' wages as Cost of Production

What is Cost of Goods Sold (COGS)?

Cost of Goods Sold (COGS) refers to the expenses directly associated with producing goods sold or services provided.

In the culinary business, COGS covers a broader scope since it includes not only raw materials but also various other costs, such as:

• Raw Materials:
  • Main ingredients like meat, fish, vegetables, or spices.
  • Additional costs like seasoning, oil, and complementary materials.
• Direct Labor Costs:
  • Salaries for chefs and kitchen staff directly involved in the cooking process.
• Supporting Operational Costs:
  • Gas or electricity used for cooking.
  • Water costs for cleaning raw materials and cooking equipment.
• Service Costs (if applicable):
  • Packaging costs for food delivery services.
  • Additional service costs, such as delivery to customers.
• Marketing and Administrative Costs:
  • Costs related to promoting the business or managing its operations.

How to Calculate Cost of Goods Sold (COGS)?

Read more: What is COGS & How can it be Calculated?

Key Differences Between Cost of Production (HPP) and COGS

The following are the main distinctions between Cost of Production (HPP) and Cost of Goods Sold (COGS):

The most fundamental difference between Cost of Production (HPP) and Cost of Goods Sold (COGS) lies in the types of costs accounted for:

Cost of Production only involves expenses directly related to the manufacturing process.

Cost of Goods Sold encompasses all costs incurred from production to the point the product or service is delivered to the customer.

Relationship Between Cost of Production and COGS with Profit

Both Cost of Production and Cost of Goods Sold (COGS) significantly impact a company's gross profit, which is calculated as follows:

If production or service costs increase without a corresponding rise in revenue, gross profit will decrease. Therefore, effective management of these costs is essential to keep the business competitive and profitable.

Impact of Inventory Management on HPP

Effective inventory management can help control HPP. Practices such as just-in-time inventory can reduce storage costs and avoid waste. Conversely, poor inventory management may result in overstocking or stock shortages, negatively affecting operational costs.

Read more: Stocktaking for Restaurants? Here Are the Benefits!

Conclusion

Although often used interchangeably, Cost of Production and Cost of Goods Sold have fundamental differences.

Cost of Production is more relevant for manufacturing companies that produce physical goods, while Cost of Goods Sold is suitable for service-based businesses that do not deal with physical products.

With an integrated ERP system, you can monitor all aspects of your business operations, from inventory to finance, on one easily accessible platform.

Schedule a demo with ESB Core here and experience how our solution can optimize your culinary business.