What is Value Added?

Value Added

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Value Added

The term “value-added” refers to the additional value created over the course of a production or service process. It’s the difference between the value of the output (goods or services) and the value of all the inputs used in the production process. In other words, it represents the increment in value that a business contributes to its products or services by undertaking certain activities.

In Economics

In economic terms, the value-added concept can be used to calculate the contribution of different sectors or activities to Gross Domestic Product (GDP). The value-added of a sector is calculated as the total output (revenue from all goods and services produced) minus the value of intermediate goods (materials and services that are consumed in production). It is a way to avoid double-counting when calculating the total economic output.

In Business

In the business context, value-added refers to activities that make a product or service more valuable to customers. This could include quality improvements, additional features, better customer service, faster delivery, etc. The concept is often used in value-added chain analysis, which breaks down the business operations into activities to see where value is added in the process and where inefficiencies exist.

Value-Added Tax (VAT)

This is a tax levied on the value added to goods and services at each stage in the production chain. It is ultimately paid by the end consumer but is collected at each stage by the business that adds value to the product.

Example of Value Added

Let’s delve deeper into the concept of “value-added” with an example involving the manufacturing and sale of wooden tables.

Example: Wooden Table Manufacturing Company

Suppose you own a small company that makes and sells wooden tables. Here’s how the value-added can be calculated at different stages of production:

1. Purchase of Raw Materials:

  • You buy raw timber for $50 and additional supplies like screws and paint for $10.
  • Total Input Cost at this stage = $50 (timber) + $10 (supplies) = $60

2. Manufacturing:

  • Your skilled craftsmen turn the timber into a well-designed wooden table.
  • You pay them $30 for their labor.

3. Value-Added in Manufacturing:

  • Value-Added = Output Value – Input Cost
  • The unfinished table can now be sold to wholesalers for $120.
  • Value-Added during manufacturing = $120 (unfinished table) – $60 (raw materials) – $30 (labor) = $30

4. Finishing:

  • Another team paints and polishes the table, adding more value to it.
  • The cost of this additional labor and materials is $20.

5. Value-Added in Finishing:

  • After finishing, the table can be sold at a retail price of $200.
  • Value-Added during finishing = $200 (final retail price) – $120 (unfinished table cost) – $20 (finishing costs) = $60

6. Total Value-Added:

  • Total Value-Added = Value-Added in Manufacturing + Value-Added in Finishing
  • Total Value-Added = $30 (manufacturing) + $60 (finishing) = $90

Here, the total value-added in the process is $90. The table that started with a raw material cost of $50 + $10 = $60 is transformed into a final product that sells for $200. After accounting for all labor and other intermediate costs ($30 for manufacturing labor and $20 for finishing), your company has added $90 of value to the raw materials.

This value-added concept can help the business understand where value is being created in the process and can also be a basis for calculating taxes like Value-Added Tax (VAT) in some countries.

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