How To Calculate Total Manufacturing Costs

    10/27/21 10:00 AM

    calculate-total-manufacturing-costKnowing your manufacturing costs are critical

    A recurring theme we’ve seen with companies over the past 25 years is they want to know their total manufacturing costs. Not only do they want to know these costs, but they want to trust the numbers are accurate, and be able to make important business decisions with that knowledge.We talk to numerous companies that are profitable, yet don’t know their true manufacturing costs. They make money, but they struggle to identify areas where they could improve, quantify whether a product or customer is profitable, and make decisions about where they should focus attention to attain added improvement. Their data is like having a scoreboard, but no statistics to show the story of the game.

    Get the full story and learn how to properly calculate total manufacturing costs by accounting for these key production data points.

    Four key elements to calculate manufacturing costs

    You need to account for four categories to have accurate manufacturing costs: labor, materials, outside services, and overhead. You also need to have processes and mechanisms in place to capture or validate those costs, regardless of the costing method you choose. Typically, many of our “to order” manufacturers choose to use actual costs as their validation. However, we see other manufacturers choose standard or average costs. Whatever type of cost you choose, the goal is to establish standards to measure against, and we want to get the standards as close to reality as possible.

    Labor

    The labor component of costing should be driven by actual time involved on the production floor, captured as the in-process product moves from operation to operation. You may want to start with capturing data in a detailed manner, including setup time, operation time, inspection time, transfer time, and then repeat the process as products move through the production line. If you have no current labor collection processes, then you may want to start simpler. The Visual South team can guide you through the best practices and process for your situation.

    Your ERP system, like the ones we use in the Infor manufacturing ERP family, should be able to give labor costs by multiplying the times collected, and by the respective labor rates. We highly advise using a shop floor automation tool, such as Infor Factory Track or Infor VISUAL Shop Floor Mobile. An automated tool will ensure the capture of accurate labor costs with simple barcode scans on and off operations, preferably using touch screen and mobile devices, or scanning a paper router with barcodes. If you write down times on paper and then manually enter labor tickets into your ERP—this method isn’t ideal, but it’s better than nothing.

    We generally advise that you always to tell your ERP system what you did, when you did it. You want accurate and real-time data to increase your level of competitiveness in the market. Having accurate data is important, so make it a priority.

    Materials

    We are currently seeing exceptional volatility in the materials market due to supply chain issues, as well as variable landed costs due to the high shipping costs. This is a scenario where having actual costs relative to materials is important because the huge fluctuations can erode profit margins quickly if you don’t know your costs, and have a way to account for them. Although we are focused on the manufacturing side of the business, sales teams need to know costs as well, so they can estimate and quote based on current prices. Salespeople using independent spreadsheets (not tied to the ERP) to pull labor, material, and outside services costs can be incurring quite a bit of risk exposure, relative to ensuring accurate assumed margins on new business. Beware!

    Capturing material costs is typically done in a couple ways. Many of our custom engineer and make-to-order customers often buy inventory directly to the job/project. The material arrives and goes directly into WIP at the purchase price. That’s easy and direct.

    However, many customers build component parts to inventory, buy parts to inventory, and then issue to the job. The critical element here is to ensure material is issued to the job, and accounted for properly. Once again, we encourage businesses to leverage the Infor shop floor automation tools to capture these transactions as they happen. Our customers use mobile devices to issue material, and also use material barcoding (where applicable) to capture those transactions. FIFO layers drive the costing for the material used and, in some cases, you can have lot-specific pricing for your material costs. Other benefits are an accurate inventory, with regard to both count and valuation. You are also able to better schedule because you trust what your system shows on inventory availability.

    Outside services

    Many of our manufacturers use a variety of outside services during the production process. For example, some customers send in-process product to other vendors for heat treating, plating, anodizing, and painting. Or, a resource is brought in to do x-rays or other services. Whatever the service provided, these activities have to be accounted for and costs captured. Luckily, outside services is one of the easier costs to calculate, simply because the items are typically tied to a purchase order, and that purchase cost is tied directly to the job or project. The outside service needs to be included in your engineering master structure, so you have a bucket to collect those costs.

    Overhead

    Understanding how to calculate manufacturing overhead cost is tricky because every company is unique. There are several ways to account for overhead, but typically it is the sum of all indirect costs associated with production. That is your calculation of total manufacturing overhead costs, and it can be broken down by month, quarter, year, etc. To calculate your overhead rate, divide your monthly overhead costs by your total monthly sales, and multiply that number by 100.

    To get your total manufacturing costs, add your labor, material, outside services, and overhead. It’s not difficult if you have proper upstream processes, and tools in place to ensure all information is captured.

    Related: 6 Shop Floor Management Techniques Learned from 30 Years of Experience

    Summary

    When learning how to calculate total manufacturing costs, begin by making sure you have engineering masters that are correct, and identify resources being used for the production process. You want to have cycle time estimates that are as precise as possible for those resources. You want to have materials identified and acceptable material pricing standards. The same goes for outside services vendors, with regard to pricing, as well as, transportation time and lead time.

     Make sure you have a way to manage and capture transactions. Capturing transactions via paper being the most basic, and using tablets and mobile devices being the most optimal.

     Visual South helps manufacturers achieve their goals regardless of software tools. If you want to discuss how you can ensure you are capturing and accurately calculating your manufacturing costs, please let us know. A great way to start the process is to simply reach out and have a free 30-minute consultation. Schedule your free assessment here.

    Tim O'Brien

    Written by Tim O'Brien

    Tim has over 20 years of successful experience helping companies improve their processes and operations using enterprise software solutions. Those enterprise solutions include Enterprise Resource Planning for manufacturers, Service Management for service oriented companies, and Enterprise Asset Management in the process manufacturing industry.