Everything You Need to Know About Manufacturing Cost
Is knowing and understanding your total manufacturing cost on the top of your to-do list?
It’s not the most glamorous subject. But taking the time to properly manage it will pay dividends in the long-run.
You can find out if you are hitting your targets.
Or if your production process is conducive to your desired level of productivity.
There are three types of manufacturing costs related to any production process. Can you name them without looking ahead in this article?
The long and short of it is this — if you don’t know your exact costs, how do you know your profit margin? You could be selling stacks of product, but if your costs are out of control, then a lot of hard work is going to waste.
It may be a cliché but is so for a reason:
“Turnover is vanity, profit is sanity.”
Don't leave gaps on your financial statement. Accurately track all your costs, so you can keep meaningful records and make informed decisions.
If you know the value of your current inventory and cost of goods sold, you can calculate your sales margins. Maybe there’s room to lean-up your manufacturing by cutting down on hidden costs to your business.
But how do you know where to start? What are manufacturing expenses beyond basic raw materials? What do you need to do to reduce these costs?
Everything will become clear in the next couple of minutes.
Don’t make the mistake of underestimating your expenses. Even small miscalculations can snowball into major issues for your business.
We have the answers to all your questions, so keep reading!
What is Manufacturing Cost?
Manufacturing cost is the sum of expenses associated with all the resources spent in the process of creating your finished product.
However, calculating and understanding it is not so obvious.
It is important to know what each element of your production process is costing you. You need to understand how to split your total manufacturing cost into its constituent parts.
The first distinction is between the three major costs components of manufacturing a product. These can be direct or indirect. There are things that never touch your product but still need to be in your total cost calculation.
That’s right — pretty much everything in your business has an impact on your costs, even if it seems separate at first glance.
What is Direct Manufacturing Cost?
Direct costs refers to everything spent on the bulk of the manufacturing process. This could be material costs (e.g. raw materials) and time costs (e.g. staff wages). They must play a physical role in assembly or production for it to be a direct cost.
But be careful!
Some materials and labor are regarded as indirect manufacturing costs (more on that below).
Whatever you do, watch out for counting costs twice by not understanding this.
What is Indirect Manufacturing Cost?
These are costs in your manufacturing process that do not come from raw materials or labor primarily used in manufacturing. This includes maintenance costs, utility bills, salary of non-manufacturing staff, and MRO.
Stay away from one common mistake:
As mentioned above, not all the materials consumed by your manufacturing process are regarded as direct costs. For example, nails and glue that hold together a wooden cabinet are indirect materials — also called consumables. Don’t forget to add the cost of your consumables to your total manufacturing cost!
One thing to watch out for is costs that come out of depreciation in the value of your raw materials. If you produce comestibles, your raw materials and finished products in-waiting could spoil. Knowing how much you are losing to situations like this is critical to keeping your business afloat. If you know that there is wastage in your manufacturing process, then you can do something about it. Every year hundreds of businesses go into the red, and management issues like this are a major cause.
The three major cost components of manufacturing a product are:
Direct materials — the primary raw materials that go into the final product;
Direct labor — all staff who have a hand in the refining, assembly, and manufacturing of your products; and
Manufacturing overheads — machining, maintenance and indirect materials and labor in a secondary or support role.
So now you have defined all your costs you can answer this question:
“What is the manufacturing cost for your product?”
What are Examples of Product Costs?
Let's use the example of a plucky Portland skateboard manufacturer. Using real terms we can identify different manufacturing costs.
Direct material: the cost of plywood to make the board;
Direct labor: the guys who make and assemble the skateboard;
Manufacturing Overhead (Indirect labor): e.g. the janitor in the workshop;
Manufacturing Overhead (Indirect material): the masking tape for holding the board in place during molding;
Manufacturing overhead (Other): includes the costs of running machines like a belt sander, or consuming spray paint canisters; and
Manufacturing overhead (Other): the cost of your workshop’s rent and utilities.
Manufacturing Cost Formula and Example
The manufacturing cost formula is as follows:
MC = Raw Materials + Direct Labor + Allocated Manufacturing Overhead
So, how does this formula work in practice? Let’s continue with our skateboard manufacturer example. We have identified our direct and indirect manufacturing costs so can apply them to the formula introduced above.
The direct materials cost for one skateboard is the sum of one deck ($20), two metal trucks ($10), and four wheels ($16) per unit.
Direct labor could average out to $10 per unit, as they produce several per hour.
Overhead costs include bearings, lubricant, paint, staff, and electricity ($10 per unit).
Raw Materials + Direct Labor + Allocated Manufacturing Overhead
(20 + 10 + 16) + 10 + 10 = 56
This brings your total to $56 for one unit. Once you have this, you can predict your total costs for a whole day’s, week’s, and even month’s production.
Keep track of everything and run the actual total costs against the predicted costs. See if they align at the end of a set time period. This is one way to monitor manufacturing cost.
One thing to keep in mind: as you scale up your manufacturing cost calculation, you need to take into account things that don’t scale at the same rate.
This could be:
• Cheaper wholesale prices when ordered in bulk — bring costs down.
• Higher maintenance costs for machines — bring costs up.
Like every part of your production process, anticipating these changes helps you stay on top of everything.
Know every figure in your manufacturing process, by using Smart Workshop Software like Katana.