Determining the manufacturing cost is a crucial step for businesses in deciding the sale price. It also affects profits to highlight weak points in the manufacturing process.
Total manufacturing cost is the sum of direct material, direct labor, and manufacturing overhead. However, many other factors are involved in this simple-looking calculation.
In this write-up, we explain the direct cost and overhead cost, which will help you calculate the total manufacturing cost correctly.
After understanding these cost components, you will be able to conduct an effective analysis to optimize the manufacturing process and make informed decisions for improvement.
Total Manufacturing Cost (TMC)
As its name suggests, all the costs, both direct and indirect, incurred in product manufacturing are added to determine the total manufacturing cost.
TMC = Direct cost (Direct Material Cost + Direct Labor Cost) + Indirect Cost (Manufacturing Cost)
Or
TMC= Direct Material Cost+ Direct Labor Cost+ Manufacturing Overhead
Direct Cost
All costs associated with producing a product, such as materials, are known as direct costs. Also, they are the major costs that can be traced to a specific product. It is further divided into sub-categories: direct material and direct labor.
Indirect Cost
Indirect costs are not directly involved in the production of a product but support the manufacturing process. Plus, these can be related to a single product or a part of the manufacturing process.
Offensively, this cost is fixed but can be variable. Common examples of indirect costs are the electricity bill and rent.
Total Manufacturing Cost
To calculate the total manufacturing cost, the calculation of the following cost factors is essential.
- Total Direct Material Cost
Material is the primary component required to manufacture a product and constitutes the first part of the direct cost.
Formula
Direct Material Cost = Initial Inventory Cost + Purchased Inventory Cost ₋ Ending Inventory
Example
A 20 cubic feet piece of wood is required to create a table. Also, the cost is $200. Therefore, 5 wood pieces are already available in the Inventory, and 25 wood pieces have been purchased. Ultimately, there are 10 wood pieces in the ending inventory.
Calculation for Direct material:
Initial inventory = 5 x $200 = $1000
Purchased inventory = 25 x $200 = $5000
Ending inventory 10 x $200 = 2000
Total Direct Material = $1000 + $5000 ₋ $2000 = $4000
While calculating direct material cost, it is important to include all direct material costs, such as:
- Raw material cost
- Import duties
- Transportation (freight in)
- Insurance (During Transit)
- Unloading and unloading charges
- Storage cost
- Normal wastage of material
| Note: This calculation is just for example. Definitely, the values would be different for businesses according to their details. Moreover, the calculation becomes more complicated if the product passes through multiple cycles for manufacturing. |
- Total Direct Labor Cost
Direct labor takes part in the manufacturing process for making a specific product. So the wages or salaries paid to such workers are considered as direct labor cost, which is a crucial component of total manufacturing costs.
Wages can be given on a per-hour, weekly, and monthly basis, depending on how long the production process is:
Formula
Direct Labor = Total Number of Hours Spent x Hourly Wage
Example
Continuing the previous example, suppose making a table requires 15 hours of labor. Let’s calculate the direct labor for making 20 tables if the wage is $20 per hour.
Formula
Direct labor = Total number of hours x Hourly wage
(20 ✕ 15) x $20 = $6000
Here, it is necessary to include all the costs that are related to direct labor, such as:
- Wages/salaries
- Over time
- Incentives
- Allowances
- Payroll taxes, etc.
-
Total Manufacturing Overhead Cost
The manufacturing overhead cost is the indirect cost that supports the manufacturing process, such as rent, insurance, maintenance, etc.
So, the total manufacturing overhead cost formula includes all the supporting cost factors specifically related to production.
Formula
Total manufacturing overhead cost = indirect labor + indirect materials + utilities + insurance + depreciation + any other overhead costs.
Example
Imagine a furniture factory, “Ironworks Pvt Ltd.” for August.
Here are their expenses:
- Indirect Labor: Ironworks Pvt Ltd pays a factory supervisor $6,000 and a maintenance crew $2,500.
- Indirect Materials: They used machine lubricants and cleaning supplies totaling $800.
- Utilities: The electricity and gas bill for the factory was $2,400.
- Insurance: The monthly premium for the factory building and equipment is $500.
- Depreciation: The depreciation on the factory’s machinery for August is $1,100.
- Other Overhead Costs: This includes the property tax on the factory building, which is $350 for the month.
Calculating:
Total Manufacturing Overhead Cost= Indirect Labor + Indirect Materials + Utilities + Insurance + Depreciation + Other Overhead Costs
Total Manufacturing Overhead Cost = ($6,000 + $2,500) + $800 + $2,400 + $500 + $1,100 + $350
Total Manufacturing Overhead Cost = $8,500 + $800 + $2,400 + $500 + $1,100 + $350
Total Manufacturing Overhead Cost = $13,650
Like other costs, it is important to consider each manufacturing overhead cost, such as:
- Indirect material
- Indirect labor
- All operating costs
- Rent
- Electricity
- Water
- Insurance
- Property tax etc
- Depreciation and maintenance
- Other services
- Safety and compliance cost
- Medical
- Refreshments
| Note: The manufacturing overhead calculator varies according to processing. For instance, expenses are available for a specific period, such as per month.
For this, businesses usually calculate an overhead rate that can be calculated by specific production over a period: dividing estimated manufacturing overhead by estimated base (hours or units). |
Critical Points for Calculation
-
Ignoring Any Cost
Recording and then adding all of the expenses is a necessary step. But often, there is some hidden cost or not of having poor records. Therefore, they are not included in the calculation; for example, forgetting to add the machine repair cost or the cleaning cost leads to inaccuracies.
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Inaccurate Allocation Of Cost
Mostly, the costs that cannot be traced to the product are allocated incorrectly. Although businesses should clearly determine which is a direct cost and which one falls in the manufacturing overhead section.
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Inclusion Of Period Cost
Total manufacturing cost comprises only costs that are associated with the completion of the manufacturing process. But results are incorrect if the administrative or marketing costs are added at this stage. Because they are not part of the manufacturing cost.
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Recording Cost Without Updates
All costs should be updated, but if not, it leads to inaccurate calculations. It’s simple, cost that do not belong to the production period leads to inaccurate results.
Simplify Calculation
Calculating total manufacturing cost includes multiple factors that become more complicated if the manufacturing procedure is long or complex.
In such a situation, using software and tools that act as a good total manufacturing cost calculator is beneficial.
It makes the entire calculator easier by just needing to focus on recording every cost. In addition, this increases the accuracy level and provides reports for better decision-making.
Wrapping-Up
A business greatly relies on the total manufacturing cost for drafting cost reports and analyzing the procedure’s effectiveness.
The calculation of total manufacturing cost is the sum of direct material, direct labor, and manufacturing overhead cost. To acquire accurate results, it is necessary to add all costs under the right category and put figures in the formula carefully.
Use of inventory software for calculating the total manufacturing cost streamlines the task as it requires minimal effort. So you can easily focus on procedure effectiveness and cost-cutting techniques.
