Manufacturing costs are a critical component of any business, often making the difference between success and failure. It is vital that businesses understand the various factors that affect their manufacturing costs and how they can be managed to ensure long-term profitability. Understanding these cost components and the importance of effective cost management can help businesses ensure their products are produced in an efficient and cost-effective manner. In this blog post, we will take a look at the various components that affect a business’s manufacturing costs, such as labor, materials, overhead, and more. We will also explore how businesses can control and manage their manufacturing costs to remain competitive and profitable. Finally, we will consider how technology can help businesses better manage their manufacturing costs. By the end of this post, you should have a better understanding of the components of manufacturing costs, the best practices for cost management, and how technology can improve the process.
3 Types of Manufacturing Costs (Direct Materials, Direct Labor, Manufacturing Overhead)
Manufacturing cost vs. production cost
There are some significant differences between production cost and manufacturing cost, despite the fact that both are used to assess the total costs a manufacturing business incurs. All costs related to a company’s ability to conduct business are reflected in its production costs. Only costs directly related to producing products are included in manufacturing costs.
Below are two examples of production costs and a factor that affects manufacturing costs and production costs in different ways.
Fixed costs are an example of production cost
Rent, office supplies, advertising costs, and other fixed costs are examples of expenses that don’t change as production changes. Manufacturing businesses include their fixed costs within production costs. This enables them to establish the wholesale price per item and calculate the total cost of production per item.
How per-item cost affects production costs and manufacturing costs differently
The total revenue rises as a business produces more goods, but the fixed costs stay the same. In general, the business becomes more profitable as the cost of producing each item decreases. However, if you focus on manufacturing expenses, the per-item cost doesn’t change significantly. In fact, increased production may result in higher manufacturing costs. For instance, the business might need to buy more equipment or hire more personnel to operate the machines in order to increase production.
What is manufacturing cost?
The total cost of manufacturing a product includes all the resources required to produce it. Manufacturing costs include the material, labor and overhead costs.
Examples of manufacturing costs
Manufacturing costs generally fall into three broad categories:
These include both direct and indirect labor costs. Salaries paid to workers in the factory, whether they are on the production line or overseeing a team on the floor, are considered direct labor costs. Costs associated with those who deliver the raw materials to your manufacturing facility are an example of indirect labor.
The materials used to create your products are all included in the material costs. The components and raw materials you use to make the finished product are referred to as direct material costs. Containers and pallets that you use to safely store your raw materials are examples of indirect material costs.
Since all expenses that aren’t related to labor or materials fall under the heading of overhead costs, it can be more difficult to predict precisely what these costs will be. Service costs, utility costs, rent payments, and equipment costs are some examples.
Some common types of manufacturing costs include:
How to calculate manufacturing cost
The formula that you use to calculate manufacturing cost is:
Raw materials plus labor costs plus designated manufacturing overhead equal manufacturing costs.
The basic procedures you should follow to determine manufacturing cost are listed below:
1. Determine the cost of raw materials
Start by determining the cost of all your raw materials. You can determine this using the following formula:
Cost of raw materials equals starting inventory plus additional purchases minus ending inventory.
You would have a total of $39,000 in raw material inventory, for instance, if you calculated that you had a total of $19,000 in raw materials at the start and bought an additional $20,000 in materials. If you find that you have a $17,000 raw material inventory at the end of the production cycle, the cost of your raw materials as a whole is $22,000.
Raw material costs equal $22,000 ($19,000 + $20,000 – $17,000).
2. Calculate labor costs
Next, you need to calculate your total labor costs. This means that in addition to the wages and salaries of any other employees involved in the production process, you also need to account for the labor costs for workers in maintenance, sanitation, bookkeeping, material handling, production lines, and factories. Remember that you only need to calculate labor for the production period that you are calculating
3. Determine manufacturing overhead costs
The last step is to calculate the overhead expenses your business incurred during a production period. This could comprise the price of your manufacturing equipment’s depreciation, property taxes, insurance for the facility’s equipment, other overhead costs, and the cost of electricity and other utilities.
4. Calculate total manufacturing cost
Add up all of your costs from steps 1, 2, and 3 to get your total manufacturing cost. Your company’s general and administrative costs, such as office rent, administrative salaries, office supplies, and executive salaries, will not be included in your total manufacturing cost.
5. Determine the cost per item
You could determine the manufacturing cost per item as an optional step. This can assist you in figuring out how much to charge for your goods and whether you need to cut production-related costs. Divide the total manufacturing cost by the quantity of products you produced during the chosen time period to determine the price per item.
Example of total manufacturing cost
To calculate total manufacturing cost, you would use this formula:
raw material price plus labor expense (less general administrative expenses) plus manufacturing overhead
In the example above, for instance, we would have $22,000 in raw materials. We would have the following costs if we had $15,000 in production-related labor costs (excluding general administrative costs) and another $10,000 in manufacturing overhead (including taxes, insurance, and equipment depreciation):
22,000 + $15,000 + $10,000 = $47,000 total manufacturing cost
What are the elements of manufacturing cost?
Direct materials, direct labor, and overhead are the three main types of costs that are incurred during the manufacturing process.
Why is manufacturing cost important?
Material, labor, and manufacturing overhead make up the three components of manufacturing costs. When the product is the relevant cost objective, a distinction is made between direct materials and indirect materials.