If you expect to gain maximum profits, you must have a thorough understanding of the costs you have to bear first. This is the ‘rule of thumb’ in the manufacturing industry. It is the first solid step the manufacturers take towards calculating their profits, losses, and areas to be improved later on. However, many newcomers in the manufacturing world still do not give enough weight to the latter, thinking it is a long process. The truth is, calculating manufacturing cost only requires a few stages.
This article covers everything about the five steps to calculate manufacturing cost.
We will uncover
- What is Manufacturing Cost?
- How to Calculate Manufacturing Cost-Formula and the Essential Steps
- What are the Five Steps to Calculate Manufacturing Cost?
- Total Manufacturing Cost Formula
- Direct Manufacturing Cost Vs. Indirect Manufacturing Cost
- Common Mistakes in Calculating Manufacturing Costs
- Cerexio Solution to Accurately Calculate Manufacturing Cost
- Calculate Manufacturing Cost to Put the Stamp on Profits
- FAQ about Manufacturing Cost
What is Manufacturing Cost?
A manufacturing cost includes all of the expenses related to creating a good or service, including the resources used in the process. Labour, materials, and overhead all contribute to production expenses.
In further depth, the categories are as follows:
Labour Costs
These consist of both direct and indirect labour expenses. Employee pay, whether on the manufacturing line or leading a team on the floor, is considered direct labour expenses. Indirect labour may involve the expenses incurred by the individuals who transport the raw materials to the production site.
Material Costs
All of the materials required to make the items are included in the material prices. Direct material costs comprise the parts and raw materials required to manufacture the completed product. Indirect material expenses include items such as containers and pallets required to properly store raw materials.
Overhead
All expenses that are not related to personnel or supplies are considered overhead costs. Rent, utilities, equipment fees, and service charges are a few examples.
Typical manufacturing cost kinds include the following:
Wages and salaries of workers actively involved in product production, including factory managers, industrial engineers, equipment operators, and quality assurance.
How to Calculate Manufacturing Cost-Formula and the Essential Steps
There is a specific formula manufacturers utilise to calculate manufacturing costs:
Manufacturing cost = Raw materials + Labour costs + Allocated manufacturing overhead
What are the Five Steps to Calculate Manufacturing Cost?
Step 1- Calculate the Raw Material Cost
First, figure out how much each raw item will cost. You can use the following formula to find this:
Beginning inventory + Purchases added – Ending inventory = Cost of raw materials
Let’s get an example to simplify how it works.
Consider that the initial raw material’s total cost is $20,000. Then your company decides to purchase another set of raw materials worth $25,000. So, the worth of the new raw materials bundle is equal to $45,000. After working on a production cycle, you find you have $15,000 worth of raw materials in hand. This number indicates that the total cost of the raw materials is $22,000.
This is how it goes:-
Cost of raw materials = $20,000 + $25,000 – $15,000 = $30,000
Step 2- Determine the Cost of Labour
Next, figure out the overall labour expenses. The labour expenses for material handlers, production line workers, factory managers, maintenance staff, sanitation staff, and bookkeepers engaged in the production process should be added.
Wages and salaries paid to workers engaged in the production process may also fall under this category.
Calculate labour just for the time of production you are considering.
Step 3- Calculate the Overhead Expenses of Production
Then, verify the company’s overhead expenses throughout a manufacturing cycle. This might include property taxes, insurance for the building and equipment, depreciation of manufacturing equipment, power and other utility costs, and other overhead costs.
Step 4- Estimate the Overall Cost of Manufacturing
In this stage, you need to add up all of the expenses from phases one, two, and three to get the overall production cost. The company’s general and administrative expenses are not included in the overall production cost.
Office rent, executive salaries, office supplies, and administrative pay are examples of general and administrative expenses.
Step 5- Establish the Cost per Item
You can determine the production cost per item as an optional step. This might assist you in figuring out how much a business might charge for its goods.
It will also assist you in determining whether the business can save costs associated with production.
You need to divide the total production cost by the quantity of items the company produced during the chosen time period to determine the price per item.
Total Manufacturing Cost Formula
If you need to know how to calculate the cost of goods manufactured in total, you can use this formula:
Direct Materials + Direct Labour + Manufacturing Overhead = Total Manufacturing Cost
For instance, using the example above, we can predict that a company may have $22,000 in raw materials.
At the same time, it can utilise a production-related labour cost of $15,000. This excludes general administrative costs, and another $10,000 in manufacturing overhead, such as taxes, insurance plans and machine breakdowns.
Based on the above data, the total manufacturing cost is,
22,000 + $15,000 + $10,000 = $47,000
Direct Manufacturing Cost Vs. Indirect Manufacturing Cost
If you can link the cost to a particular product, that is the main criterion to decide how direct and indirect production expenses vary. For instance, the direct raw materials used to create a product are included in the direct manufacturing cost. Commissions and labour payments may also be included. On the other hand, fixed expenses, including space leasing fees, quality control expenses, and personnel wages, are examples of indirect manufacturing costs.
Common Mistakes in Calculating Manufacturing Cost
If you wish to keep your production pricing, budgeting, and profitability at top levels, you must take care of the precise calculation of manufacturing cost in the first place. Still, a lot of businesses make mistakes that might skew their cost estimates and result in bad business choices. These are a few of the most frequent errors we see in calculating manufacturing cost:
Ignoring Hidden Expenses
Do not think all of your expenses and the costs you bear are visible all the time. This means you have another layer of hidden manufacturing cost! Having said that, did you take the cost of modest equipment repairs, trash disposal, and upkeep into your account? If you take each of these costs separately, it may not seem to be a huge number. However, when you combine them, you will notice that it has a big effect on the overall cost of production. This is why these expenses are too important. Underestimating them or not giving them the proper weight will end up impacting your pricing and lower profit margins.
Inaccurate Overhead Allocation
Accurately allocating overhead expenses like electricity, factory rent, and equipment depreciation is frequently difficult. Some businesses could divide overhead equally among their goods without taking resource utilisation into account. This misallocation can skew profitability assessments and company decisions by making some items look more expensive and others less expensive than they actually are.
Merging Manufacturing and Administrative Costs
Including general administration costs in manufacturing cost calculations, such as marketing, executive incentives, or office wages, is another frequent error. Only costs directly related to production should be covered by manufacturing costs. Inflating manufacturing costs by including non-production expenditures might result in overpriced goods or inaccurate assessments of production efficiency.
Ignoring Variations Particular to a Product
Another common mistake is to treat all items as though they use resources equally. Materials, labour, and machine time may vary depending on the product. Pricing strategies may be impacted, and the cost per unit may be distorted if these variances are ignored.
Cerexio Solution to Accurately Calculate Manufacturing Cost
Cerexio is presenting a robust Manufacturing Execution System that comes with an embedded financial planning model. Using this feature, your company can calculate manufacturing costs with 100% accuracy. Your workers do not have to keep an eye on all the expenses around the clock, as the financial data capturing, migrating, analysing and reporting is in good hands with Cerexio. This is an outstanding method for manufacturers to boost their profits through better financial understanding.
Calculate Manufacturing Cost to Put the Stamp on Profits
Gaining profits in the manufacturing world relies on one theory: you need to know how to find the cost of goods manufactured. With accurate calculation methods, you take the first step forward to maximise profitability 10 times better and faster.
FAQ about Manufacturing Cost
Overhead costs are the aspects that impact your long-term pricing. Instead of relying on direct costing for long-term pricing decisions, you can go with methods such as job costing, standard costing, or activity-based costing.
There is no one particular kind of cost that receives the highest weight. Considering every cost aspect, we can bring six major types of manufacturing costs that need your attention, varying from labour costs, costs for raw materials, customising parts or designs, tooling, and volumising to certifying precision.
The total production cost divided by the quantity of units produced is the average cost. Another way to get it is to add up the average fixed and variable expenses.
