In this comprehensive guide, we will explain what manufacturing costs are and delve into: <\/p>\n\n\n\n
- \n
- The different types of manufacturing costs,<\/li>\n\n\n\n
- The step-by-step process of calculating them,<\/li>\n\n\n\n
- Examples of manufacturing costs, and<\/li>\n\n\n\n
- The benefits of calculating manufacturing costs.<\/li>\n<\/ul>\n\n\n\n
Let\u2019s get started.<\/p>\n\n\n
\n![\"Manufacturing](\"https:\/\/clockify.me\/blog\/wp-content\/uploads\/2023\/09\/Manufacture-costs-cover.jpg\")
<\/figure>\n<\/div>\n\n\nWhat are manufacturing costs?<\/h2>\n\n\n\n
Manufacturing costs, also called product costs, are the expenses a company incurs in the process of manufacturing products.<\/p>\n\n\n\n
Manufacturing costs include:<\/p>\n\n\n\n
- \n
- Direct costs<\/strong> and <\/li>\n\n\n\n
- Indirect costs<\/strong>. <\/li>\n<\/ul>\n\n\n\n
Accurate cost calculation helps companies identify the processes or materials that are driving up manufacturing costs and determine the right pricing of products \u2014 the keys to remaining profitable.<\/p>\n\n\n\n
That\u2019s not all.<\/p>\n\n\n\n
According to McKinsey\u2019s research<\/a>, cutting down manufacturing costs, in addition to boosting productivity<\/a>, is the key for manufacturing companies to remain competitive.<\/p>\n\n\n\n
Track your costs with Clockify<\/a><\/p>\n\n\n\n
Now, let\u2019s explore both types of costs in more detail.<\/p>\n\n\n\n
What are direct manufacturing costs?<\/h3>\n\n\n\n
Direct manufacturing costs are expenses that can be attributed directly to the production of a specific product. They include costs related to: <\/p>\n\n\n\n
- \n
- Direct materials:<\/strong> these are the tangible inputs (or raw materials) used in the manufacturing process. For instance, the cost of the screen and electronic components would be considered direct material costs if these materials are readily traceable to the finished product (for example, glass used to make light bulbs). <\/li>\n\n\n\n
- Direct labor:<\/strong> this involves the wages and benefits paid to workers who are directly involved in assembling or creating the product, such as welders, assemblers, and machine operators. For example, the wages of assembly line workers working on the smartphone production line fall under direct labor costs. In addition to basic wages, direct labor costs<\/a> will also include overtime pay, payroll taxes, and benefits (health insurance, workers’ compensation, retirement plans, and contributions to social security or pension funds).<\/li>\n\n\n\n
- Expenses directly linked to the manufacturing process or the manufactured product:<\/strong> costs associated with the use of utilities like electricity, water, and natural gas that are directly tied to the production process also qualify as direct costs. <\/li>\n<\/ul>\n\n\n\n
What other costs should you include when computing the cost of direct materials? <\/p>\n\n\n\n
According to Zaher Dehni<\/a>, EA-certified tax professional at Taxfully, you will also need to consider:<\/p>\n\n\n\n
- \n
- The procurement price of raw materials (the cost involved in finding suppliers, storing raw materials, and so on),<\/li>\n\n\n\n
- The cost of shipping the raw materials to the production site, and <\/li>\n\n\n\n
- Any pertinent duties (a form of tax) associated with importing raw materials.<\/li>\n<\/ul>\n\n\n\n
When you add up all these direct costs, you get the Cost Of Goods Sold<\/strong> (COGS), a term used in accounting when preparing the company\u2019s financial statement.<\/p>\n\n\n\n
What are indirect manufacturing costs?<\/h3>\n\n\n\n
Indirect manufacturing costs include all other expenses incurred in manufacturing a product except <\/em>direct expenses.<\/p>\n\n\n\n
These indirect costs, also called factory or manufacturing overheads, include costs related to property tax, insurance, maintenance, and other indirect operations that support the production process.<\/p>\n\n\n\n
According to a study conducted by McKinsey<\/a>, these indirect costs account for 8% to 12% of the overall manufacturing costs.<\/p>\n\n\n\n
Now that you are familiar with the components that constitute manufacturing costs, let’s move on to the process of calculating these expenses.<\/p>\n\n\n\n
Manage expenses with Clockify<\/a><\/p>\n\n\n\n
How to calculate total manufacturing cost?<\/h2>\n\n\n\n
Calculating the total manufacturing cost involves calculating the costs of:<\/p>\n\n\n\n
- \n
- Direct materials,<\/li>\n\n\n\n
- Direct labor,<\/li>\n\n\n\n
- Other direct expenses, and<\/li>\n\n\n\n
- Factory overheads.<\/li>\n<\/ul>\n\n\n\n
Here is the simple formula to calculate the overall manufacturing cost<\/strong>:<\/p>\n\n\n\n
Manufacturing cost = the cost of direct materials + direct labor + other direct expenses + factory overhead (manufacturing overheads)<\/em><\/p>\n\n\n\n
<\/div>\n\n\n\nLet\u2019s go through all the steps for calculating total manufacturing costs. <\/p>\n\n\n\n
Step #1: Calculate the cost of direct materials<\/h3>\n\n\n\n
To calculate the cost of direct materials<\/a> you need to know the cost of inventory. Let\u2019s see how to find out the value of inventory.<\/p>\n\n\n\n
First, collect cost information<\/strong>. Start by making a list<\/a> of all the direct materials that are used to make the specific product and obtain the cost information for the direct materials you have identified. <\/p>\n\n\n\n
Next, calculate the value of the existing inventory<\/strong> if the manufacturing company already has a stock of materials from a previous period.<\/p>\n\n\n\n
Then, add up the cost of new inventory<\/strong> \u2014 this is the cost of raw materials you purchase to manufacture the product.<\/p>\n\n\n\n
Now, add the value of existing inventory to the cost of purchasing new inventory to calculate the cost of direct materials. <\/p>\n\n\n\n
From this, subtract the remaining inventory after manufacturing the product. This gives you the value of direct materials used, according to M.C. Shukla, the author of Cost Accounting: Texts And Problems<\/em><\/a>.<\/p>\n\n\n\n
\nFor instance, let\u2019s say a company has an existing inventory worth $1,500. <\/em><\/p>\n\n\n\n
The company purchases $1,000 worth of new materials to make product X.<\/em><\/p>\n\n\n\n
Now, the total inventory value is:<\/em><\/p>\n\n\n\n
$1,500 + $1,000 = $2,500<\/em><\/p>\n\n\n\n
After manufacturing product X, let\u2019s say the company\u2019s ending inventory (inventory left over) is $500.<\/em><\/p>\n\n\n\n
This means, the cost of direct materials is:<\/em><\/p>\n\n\n\n
$2,500 – $500 = $2,000<\/em><\/p>\n<\/div><\/div>\n\n\n\n
<\/div>\n\n\n\nStep #2: Compute the cost of direct labor<\/h3>\n\n\n\n
To calculate the direct labor cost, you will need to know the following:<\/p>\n\n\n\n
- \n
- The total number of employees working on the production line,<\/li>\n\n\n\n
- The total number of hours each employee works, and<\/li>\n\n\n\n
- The hourly rate of labor.<\/li>\n<\/ul>\n\n\n\n
To obtain these details, you can refer to the company\u2019s employment records that has a list of all the employees and their hourly rates. <\/p>\n\n\n\n
Tracking the number of hours each employee works on the production line can be tricky. This is where a manufacturing time tracking app<\/a>, such as Clockify, comes in handy. <\/p>\n\n\n\n
With Clockify by CAKE.com<\/a>, workers can quickly clock in and clock out.<\/p>\n\n\n
\n![\"Time](\"https:\/\/clockify.me\/blog\/wp-content\/uploads\/2023\/09\/Time-kiosk-Clockify.png\")
Clockify makes it easy for employees to clock in\/out <\/figcaption><\/figure>\n<\/div>\n\n\n As employees use Clockify to clock in and out, employers gain insights into the total number of hours each employee worked on each production line. You can also see the total number of hours worked by the entire team.<\/p>\n\n\n\n
Try Clockify by CAKE.com today<\/a><\/p>\n\n\n
\n![\"Clockify](\"https:\/\/clockify.me\/blog\/wp-content\/uploads\/2023\/09\/Clockify-dashboard.png\")
Track the number of hours worked on each production line<\/figcaption><\/figure>\n<\/div>\n\n\n Once you know the number of hours worked by employees, you can calculate the cost of direct labor<\/a> with this formula:<\/p>\n\n\n\n
Direct labor = Hourly labor rate \/ the total number of hours worked on the production line<\/em> by all employees<\/em><\/p>\n\n\n\n
<\/div>\n\n\n\nFor instance, let\u2019s say the hourly rate a manufacturing company pays to its employees is $30.<\/p>\n\n\n\n
Here are the number of hours each worker worked:<\/p>\n\n\n\n
- \n
- Worker 1\u2014 6 hours<\/li>\n\n\n\n
- Worker 2 \u2014 7 hours<\/li>\n\n\n\n
- Worker 3 \u2014 9 hours<\/li>\n<\/ul>\n\n\n\n
So, the direct labor cost per hour is:<\/p>\n\n\n\n
$30 (hourly labor rate) \/ 22 (total number of hours worked) = $1.36<\/em><\/p>\n\n\n\n
<\/div>\n\n\n\nWhile this is a simplified view of direct labor calculation, accountants also include the benefits, overtime pay, training costs, and payroll taxes when calculating the hourly rate.<\/p>\n\n\n\n
\n\ud83d\udca1 Clockify Pro Tip<\/strong><\/p>\n\n\n\n
Master labor cost calculations with smart tips and easy-to-use calculators. Read our blog post:<\/p>\n\n\n\n
- \n
- How to calculate labor cost + labor cost calculators<\/a><\/li>\n<\/ul>\n<\/div><\/div>\n\n\n\n
Step #3: Add up the other direct expenses<\/h3>\n\n\n\n
The next step is to calculate the costs of utilities (electricity, water, or gas) that are directly used in the manufacturing process (for example, fuel used to operate the production equipment).<\/p>\n\n\n\n
Step #4: Calculate the indirect costs (manufacturing overheads)<\/h3>\n\n\n\n
To calculate the indirect manufacturing costs you first need to identify all the indirect costs associated with the manufacturing process. <\/p>\n\n\n\n
These costs typically fall into categories such as: <\/p>\n\n\n\n
- \n
- Rent, <\/li>\n\n\n\n
- Utilities, <\/li>\n\n\n\n
- Depreciation, <\/li>\n\n\n\n
- Maintenance, <\/li>\n\n\n\n
- Supplies, <\/li>\n\n\n\n
- Insurance, and <\/li>\n\n\n\n
- Indirect labor (e.g., supervisors and quality control staff).<\/li>\n<\/ul>\n\n\n\n
Once you identify the indirect costs, get detailed expense data for each of these overhead cost categories for a specific period, such as a month or a year. You can track expenses<\/a> by looking at your invoices, receipts, and records of all expenditures related to manufacturing overhead.<\/p>\n\n\n\n
Be sure to allocate overhead costs to the respective cost centers (specific departments, processes, or machines in the manufacturing facility that contribute to the manufacturing costs). <\/p>\n\n\n\n
For example, you can allocate depreciation costs of refrigerators to the department that uses them. <\/p>\n\n\n\n
Here is the breakdown of overhead costs of company Z that makes smartphones: <\/p>\n\n\n\n
- How to calculate labor cost + labor cost calculators<\/a><\/li>\n<\/ul>\n<\/div><\/div>\n\n\n\n
- Direct labor:<\/strong> this involves the wages and benefits paid to workers who are directly involved in assembling or creating the product, such as welders, assemblers, and machine operators. For example, the wages of assembly line workers working on the smartphone production line fall under direct labor costs. In addition to basic wages, direct labor costs<\/a> will also include overtime pay, payroll taxes, and benefits (health insurance, workers’ compensation, retirement plans, and contributions to social security or pension funds).<\/li>\n\n\n\n
- Indirect costs<\/strong>. <\/li>\n<\/ul>\n\n\n\n
- Direct costs<\/strong> and <\/li>\n\n\n\n
![\"Francis](\"https:\/\/clockify.me\/blog\/wp-content\/uploads\/2023\/09\/Francis-Fabrizi-630x630.jpg\")
<\/figure>\n<\/div>\n\n\n\n![\"Illustration\"](\"https:\/\/clockify.me\/blog\/wp-content\/themes\/cake-blog\/theme\/images\/banners\/clockify\/templates@2x.png)
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