How much money do you spend to make one widget? Seems mundane to compute the manufacturing cost of a single item – but it’s the ticket to profitability.
Without knowing how much money it will take to make your product, you can’t possibly know how to price your product to turn a profit. If you’re a product-based company, calculating your total manufacturing costs is essential.
This brief tutorial will show you how to calculate your manufacturing costs. But if you’re looking for more detail, check out our complete guide to calculating total manufacturing costs, with examples!
OK, let’s dive in!
What is “total manufacturing cost?”
Total manufacturing cost includes all costs incurred in manufacturing a product. This includes raw materials, labor, overhead, and other associated costs. Each of these costs are essential for an accurate cost of the end product.
Types of manufacturing costs
Calculating the total cost to manufacture a product can be daunting. There are many factors to consider, such as materials, labor, and overhead. However, with careful planning and a clear understanding of all the costs involved, it is possible to get an accurate picture of your total costs. Getting an accurate manufacturing cost allows you to appropriately price your products for sale — and make a profit!
Here’s a breakdown of how to compute the individual components to figure your total manufacturing costs.
Direct labor cost
Labor costs equal the estimated number of man hours multiplied by the hourly rate for each man hour. For example, if you estimate it will take 20 hours to manufacture a product and employee wages are $15/hour, your total labor cost equals $300 (20 hours x $15/hour). Of course, this is a simple illustrative example assuming all employees make the same hourly rate.
Here’s the three-step process to calculate labor costs:
- Determine the number of labor hours required to produce your product. This includes time spent on assembly, packaging, and quality control.
- Multiply the number of labor hours by the hourly wages of your workers. You can use average hourly rates if employees are paid differently, or businesses can estimate based on each employee’s contribution to the product. For example, if each employee has a different role requiring different hours on the project, each can be calculated separately. The labor costs of each employee are added together for total labor costs for producing the product.
- Add all other labor costs, such as benefits or taxes associated with your workers’ salaries.
Note that some businesses may also calculate overtime or peak time costs separately.
Direct material cost
One of the most important things you can do is accurately calculate your direct materials cost. This includes both the cost of the raw materials used in production and any shipping or tariffs associated with those materials.
With an accurate direct materials cost, you’ll be able to price your products and make sound business decisions about your manufacturing processes.
A lot of this information will come from your suppliers. Be sure to factor any unit discounts, cash discounts, or net term discounts. Account for each item that goes into manufacturing your product – including raw materials used in production.
You’ll also want to figure the costs associated with the availability of raw materials – the lead time. Factor shipping costs and tariffs (taxes) associated with raw materials. For many manufacturers, these costs can be high and vary widely depending. However, they’re necessary to accurately compute your direct materials cost.
To determine your overhead cost, you’ll need to know your indirect costs. You’ll need to compute your indirect, or overhead, costs. Here’s the formula:
- To calculate overhead cost, add up all the costs, except direct labor costs, that you’ve paid over a specific period of time, for example, three months or a quarter of the year.
- Compute the hourly cost of overhead. You’ll do this by dividing the results from above by the number of hours for that time period (a quarter is approximately 500 hours). This will give you an hourly rate for overhead costs.
- Multiple this figure by the number of hours needed to manufacture the product.
Overhead costs include items like:
- Office supplies,
- Advertising expenses,
- Professional expenses,
Compute total manufacturing costs
Once you’ve calculated the individual costs associated with manufacturing your product, you can compute the total manufacturing costs.
Product cost formula
Total manufacturing cost = direct materials +direct labor costs + manufacturing overhead
It’s important to add additional labor costs, raw material costs, product warranty expenses, and miscellaneous manufacturing costs to the total amount. We recommend adding 10% to the final number to get a more accurate picture of how much your products are actually costing you to manufacture.
Of course, tracking your costs over time will tell you how accurate your calculations were, but this definitely will give you a starting point.
Once you know your manufacturing costs, you can use that to price products, determine profitability, or compare costs with other manufacturers.
Before moving on, you should know there are two methods for calculating total manufacturing cost: direct and indirect. The direct method assigns all manufacturing costs directly to the product being manufactured. The indirect method assigns manufacturing costs based on department or activity. We’ve outlined computing total manufacturing costs based on the direct method – this gives you the most accurate picture of actual costs.
The importance of knowing total manufacturing cost
Understanding your manufacturing cost is critical to your success if you’re a product-based company. After all, if you don’t know how much it costs to make your products, you can’t price them correctly or make sound decisions about where to source your materials.
Whenever you calculate manufacturing costs, you should be aware of your manufactured product’s price point, shipping fees, and total taxes (just your share). These are integral to calculating your product’s final price.
The benefits of knowing your total manufacturing cost
Determining profitability is directly related to knowing how much money you spend to manufacture the products you sell. There are substantial benefits to knowing your total manufacturing costs, including:
- Evaluating ways to reduce your costs.
- Determining your company’s financial health.
- Making informed pricing decisions.
- Finding ways to minimize manufacturing waste.
- Understanding how efficient your operations are.
Manage manufacturing cost with DEAR Systems
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With DEAR systems by your side, you’ll be able to reduce superfluous costs and increase profitability. Book a 14-day free trial now.