Businesses need to assess manufacturing costs to maintain the business’ stability. Manufacturing costs are a significant metric to consider for companies. If this metric is assessed accurately, then the financial teams can focus on improving the financial position of the business. In addition, it has a cost formula which can be used to calculate the total cost of the raw materials to turn it into a finished product. If you can crack and comprehend these expenses, then it will be easier to find ways to increase the company’s revenue and make better decisions for the company.
Manufacturing costs fluctuate frequently due to a lot of factors. However, businesses must create strategies to predict costs to reach their target as the business’s success mainly depends on profitability. In this blog, let us learn more about manufacturing costs in detail.
What is Manufacturing Costs?
Manufacturing costs are the total costs incurred during the entire production process till the finished product is made. These costs include labour, raw materials and overhead costs. Given below is the explanation of the three involved costs:
→Materials costs
Direct materials are all the raw materials used to create a finished product. Direct material costs are the parts and materials used to make the finished product. Indirect material costs are more constant, these are the items used to support the manufacturing. For example, containers or pallets are used to store raw materials.
→Labour Costs
These costs can be categorized into direct costs and indirect costs. All the labour costs associated with the production unit come under direct labour. Thus, the employees involved in refining, assembly, and manufacturing of the goods belong to direct labour.
→Manufacturing Overhead Costs
Manufacturing overhead costs are operational costs incurred to make the production process happen. These costs include rent, energy bills etc. The production process cannot happen without power and energy. Hence all these costs come under overhead costs.
Suppose your machinery or equipment breakdowns, then the repair costs are included in the manufacturing overhead costs. In addition, it also includes indirect costs that are not associated with direct and indirect manufacturing costs. Some of the examples of overhead costs are given below:
- Maintenance costs
- Utility bills
- Equipment/machinery repairs
- Property taxes
- Factory-related insurance
- Factory assets depreciation costs
What is the Difference Between Direct and Indirect Manufacturing Costs?
Direct manufacturing costs will fluctuate based on the total amount of production taking place. Indirect manufacturing costs are more constant and fixed and mostly involve overheads which was mentioned earlier.
Indirect materials are the resources that are not used directly for the making of the finished product. These costs wouldn’t be visible(won’t be a part of BOM). Some examples of indirect costs are glue, water, cleaning products etc. which are used during the production process.
Indirect labour costs are the costs incurred by using the labour, the labourers who weren’t directly involved in the manufacturing process. Some examples can be supervisors, managers, cleaners etc.(employees who are responsible for planning and maintenance of the production process)
How to Calculate Total Manufacturing Cost?
Calculate the total manufacturing cost using the formula given below:
• Manufacturing cost = Raw materials + Labor costs + Allocated manufacturing overhead
You can calculate the total manufacturing cost in five steps given below:
1. Determine the cost of the Raw Materials
For example, Beginning Raw Materials Total: Rs 50,000
Additional Purchase of Raw Materials: Rs 30,000
New Raw Materials Total: Rs 80,000
If, at the end of the production cycle, the remaining raw material inventory is valued at ₹25,000, then the total cost of the raw materials used in production would be:
Cost of Raw Materials = Beginning Raw Materials Total + Additional Purchase – Ending Raw Materials Inventory
Rs 50,000 + Rs 30,000 – Rs 25,000 = Rs 55,000
So, in this example, the total cost of the raw materials used in production would be Rs 55,000.
2. Compute Labour Costs
In this step, the labour costs are calculated such as maintenance for employees, sanitation labourers, bookkeepers involved in the production process, factory managers, production line employees and material handlers. Employee wages and salaries also come under these labour costs. The labour costs have to be calculated for the specific production period.
3. Identify Manufacturing Overhead Costs
In this step, calculate the manufacturing overhead costs of a specific production period. Manufacturing overhead costs include electricity charges, depreciating equipment used for production, property taxes, insurance for equipment and facility etc.
4. Calculation of Total Manufacturing Cost
For calculating manufacturing costs, the above there steps are added. General and administrative costs are excluded from the total manufacturing cost. Office rent, administrative wages, office equipment and executive salaries are included in the general and administrative costs.
5. Identify Cost Per Item
All the above four steps are essential to calculate the total manufacturing cost. However, this step is optional. This step is essential for the business to identify the price paid for each manufacturing function. By determining the cost of each item, the company can find ways to reduce manufacturing costs. By dividing the total manufacturing cost by the total number of products the company produced in a specific period, the cost per item can be calculated.
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Example of Total Manufacturing Cost
The total manufacturing cost can be calculated by using the formula given below:
• Cost of raw materials + Labor costs (minus general admin costs) + Manufacturing overhead
1. Direct Materials Cost: Rs 60,000
2. Direct Labor Cost: Rs 40,000
3. Manufacturing Overhead: Rs 30,000
4. Other Costs (if applicable): RS 10,000
Total Manufacturing Cost = Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead + Other Costs
Rs 60,000 + Rs 40,000 + Rs 30,000 + Rs 10,000 = Rs 1,40,000
In this example, the total manufacturing cost is Rs 1,40,000. This includes the expenses for materials, labour, overhead, and any other relevant costs incurred during the manufacturing process.
What are the benefits of Using the Total Manufacturing Cost Formula?
Enumerated below are some of the importance of total manufacturing costs:
→Minimizes Manufacturing Costs
Manufacturing cost is the expenses related to the making of a finished product. We have learned in the above topics to calculate the total manufacturing costs by determining various steps. This will help in identifying the wastage and it will aid in reducing the cost of manufacturing products. This will help lower the cost of the product without compromising the quality which will encourage returning customers. Hence, this will ensure higher net revenues for the company.
In addition, when the company lowers the costs of manufacturing, the business will expand opening room to hire more workers which will be beneficial for the Indian Economy.
→Enhances Transparency and Clarity of the Business Health
The financial health of the business depends on many factors. One of the significant factors is manufacturing costs. By applying the total manufacturing cost formula, it will be easier to comprehend the financial situation of the business. Thus, this insight will help you make better decisions for the business(regards to spending and investing). Sorting out all these will help the business to grow.
→Insightful Decisions Around Pricing
The total manufacturing costs will give insights that will help other strategies too. The insights derived from analyzing total manufacturing costs also influence other strategic decisions, including your sales and pricing strategies. If your profits fall short of expectations, it may signal the need to reevaluate your current sales approach and explore new avenues, like venturing into e-commerce.
Should you determine that costs are optimized but revenue remains a challenge, the next step might involve adjusting your pricing strategy. Setting prices too high may drive customers to competitors offering better deals, while excessively low prices may hinder your ability to generate the necessary revenue for profitability.
Based on the market norm, the cost of the product must be set, identifying the fine balance.
→Reduced Waste
If you comprehend the total manufacturing cost, it will be easier to reduce waste occurring in the manufacturing process. On closer inspection, you will understand the wastage and why materials are expensive. In addition, the manufacturing cost is efficient enough to reduce excess usage of resources. Hence less wastage will save costs, reduce pressure on working capital, and increase the cash flow.
→Insights that Drive Efficiency
Manufacturing costs are an effective method to analyze and reduce costs. It gives an accurate report of all the actions happening in the manufacturing. These actions can be introspected and unnecessary ones can be removed which will help in reducing costs. Plus, it increases efficiency and a great level of customer satisfaction. It gives a 360-degree detail of all the stages of the manufacturing process. This visibility can help in making better decisions which drive business efficiency.
Conclusion
Manufacturing costs is the total amount of all the costs of resources used in the manufacturing process to make finished goods. Relying on automation is also best to calculate manufacturing costs without any error. ERP Software is also an advanced technology which helps in managing production cycles, resource management, safety stocks, reorder points, and many more benefits. MRP (Materials Requirements Planning) can also calculate manufacturing costs error-free.
