In order to engage profitably in the manufacturing of goods, it’s necessary to give consideration to a variety of factors. “Manufacturing cost” is a blanket term that is used to refer to all of the expenditures that are necessary to produce a single unit of a given good. Manufacturing cost is subdivided into three more specific categories: Direct material costs, direct labor costs, and manufacturing overhead. Precise calculation of manufacturing cost is important for making profitable manufacturing plans and decisions. Detailed attention to manufacturing costs isn’t negligible for industrialists and manufacturers.
What are Manufacturing Costs?
“Manufacturing cost” refers to the total expenditures necessary for producing a given manufactured good. A variety of outlays is necessary for producing a unit of manufacturing. This variety goes so far as to include expenditures that might not be obvious at first glance. The calculation of manufacturing cost considers the cost of the necessary materials. Also, it considers direct costs as the cost of labor, space, utilities, and repairs, to give a few examples. Beyond this, the expenses necessary for maintaining factories and logistical infrastructure are components of manufacturing costs.
What are the Components of Manufacturing Costs?
The components of manufacturing cost can be conveniently divided into three sub-categories. The first of these is “direct material”, which consists of the cost of the materials needed to produce a given good. The second is “direct labor”, which consists of the cost of the labor needed to produce a given good. The third is “manufacturing overhead”, which comprises all of the ancillary outlays it is necessary to make in order to produce a given good. Manufacturing overhead itself includes a variety of hypo-sub-categories. The depreciation of tools and instruments, spare parts, repair labor, quality assurance, insurance payments, and the salaries of management staff are just a few of the hypo-sub-categories that make up manufacturing overhead.
1. Direct Labor
“Direct labor” refers to the cost of the immediate labor needed to produce a given manufactured good. This mainly consists of the pay rate that needs to be offered in order to attract workers with the requisite competence to manufacture the goods.
2. Direct Materials
“Direct materials” refers to the cost of the materials of which a given manufactured good consists. Manufactured goods are manufactured from materials. Every material has a price. The price of materials fluctuates with the ebb and flow of the market. The market price at a given time for the materials necessary to produce a given good is the direct materials cost for that good.
3. Manufacturing Overhead
“Manufacturing overhead” refers to all of the ancillaries outlays that it is necessary to expend in order to produce a given manufactured good. Considering the three sub-categories of manufacturing cost, this is the most complex and nebulous sub-category of them all. A wide variety of expenditures go into the production of the smallest manufactured good. In essence, all of the expenditures of an entire manufacturing company can be divided into a continuum whose infinitesimal points are the items that the company produces. Manufacturing overhead has a bewildering heterogeneity, including as it does everything from the salaries of support and management staff, to insurance, to utilities, to rent, to public and private infrastructure costs. Yet in spite of this, it’s vital to calculate as precisely as possible the expenditures that go into the production of every single individual item that your company manufactures.
Why are Manufacturing Costs Important?
It’s of the essence to calculate manufacturing costs as precisely as possible. This is because every penny that is wasted in the production of a manufactured good is a penny that goes out of your bottom line and into someone else’s. Such wastefulness will put you at a disadvantage in the sanguine-tinted water of the market shark tank. Thus an atomic level of precision in calculating manufacturing costs is much-to-be-desired for the competitive advantage it gives manufacturers. On the other hand, those who neglect manufacturing costs are liable to be torn to shreds by their more punctilious adversaries.
Where are Manufacturing Costs Recorded?
In their most detailed form, manufacturing costs are recorded in notes appended to financial statements. These notes are drawn from entries found in other places on the balance sheet. For example, the expenditures made in order to acquire material and labor will be taken from the appropriate sections of the balance sheet. Other elements of manufacturing cost may require delving deeper into the methods of financial analysis. For example, comparing manufacturing costs over time will require reference to inflation-weighted historical costs.
How may Manufacturing Costs be Reduced?
Some ways to reduce manufacturing costs are as follows.
- Reduce Labor Costs. Pay close attention to the amount of money you are spending on your workforce. Be sure that every employee in your company is engaged in work that benefits the company’s bottom line. Ensure that the salaries you are paying are competitive enough to retain the best people, but not so exorbitant as to cut into the company’s ability to grow, expand, and attract investment. Provide retraining opportunities to your workers in order to increase the value they offer to the company, and compensate them accordingly. When preparing your employees’ work schedules, strike a balance between productivity and efficiency, so that the company’s needs are met without overscheduling.
- Reduce Material Costs. There are several ways to reduce material costs. Be sure that you are getting the best price for your materials by negotiating with your suppliers. Find less-expensive substitutes without compromising the quality that your customers expect. Just-in-time supply chains can help you ensure that your company has as little excess material stock as possible, although you’ll need to be on the lookout for supply-chain disruptions. Perhaps most importantly, review the manufacturing processes your company uses to eliminate waste.
- Reduce Manufacturing Overhead. Rent is often the most significant element of manufacturing overhead, so you’ll need to use the spaces you rent as efficiently as possible. On a recurring basis, check to be sure that the profit your company is making from the products it manufactures outweighs your rent expenditures. Buy high-quality equipment that won’t break down as often, and continually check that your maintenance outlays are appropriate and targeted. Review what you’re spending on office supplies, logistics, and management and support activities and staff, and reduce costs where you can without sacrificing the functioning and morale of the company.
How is the Cost of Manufacturing Calculated?
The following is a brief guide to calculating manufacturing costs.
- Determine the amount of money your company is spending on materials, labor, and overhead within a certain period of time.
- Add the three numbers together.
- Then, determine the number of units your company produced during that period.
- Divide the total manufacturing cost by the number of units produced.
- The result is the approximate amount it costs your company to make a single item. The more accurate your assessment of costs, the more accurate your result will be.
What is the Manufacturing Cost Flow?
The flow of manufacturing cost is a diachronic perspective that tracks the cost of manufacturing a certain good over time. Several accounting techniques exist that seek to account for the temporal dimension of the manufacturing process. Two of the most common of these techniques are FIFO (“first in, first out”) and LIFO (“last in, first out”), with reference to the entry of the manufacturing costs of inventory. Another is the Weighted Average Cost, which is determined by dividing the cost of goods available for sale by the number of units in inventory. The use of the cost flow perspective allows for the various components of manufacturing cost and their variations to be visualized more easily and to be recorded more accurately.
Is Manufacturing Cost a Variable Cost?
Yes, the manufacturing cost is a variable cost. The more items that a manufacturing company produces, the higher its manufacturing cost will be. This means that it is necessary not to neglect the level of demand for your product. Overproduction occurs when a company produces more units than there is consumer demand. Inventories pile up, meaning that costs are not offset by profits from sales.
What is the Difference Between Manufacturing and Production Cost?
Manufacturing cost and production cost are two different perspectives on the expenditures necessary to operate a manufacturing enterprise. Manufacturing cost is calculated with reference to the item being manufactured, the cost-per-item. Production cost takes a more general view, simply the expenditures of a company over a given period. Like manufacturing cost, the production cost is broken down into the various categories of materials, labor, and overhead, while also including certain indirect costs that are not directly tied to the manufacture of materials, such as administrative salaries. Consideration of manufacturing cost together with production cost gives a complete and detailed view of the profit margins for producing and selling a given manufactured good. This allows for competitive prices to be set.