Manufacturing Cost

See Also:
Activity-based Costing (ABC) vs Traditional Costing
Absorption vs Variable Costing
Average Cost
Standard Cost
Cost of Goods Sold (COGS)
Absorption Cost Accounting

Manufacturing Cost Definition

Defined as the labor, material, and overhead costs in producing a finished product, manufacturing costs are the most significant factor in any manufacturing business.

Manufacturing Cost Explanation

Many explain manufacturing cost as the cost to bring a product from raw material to the point where it can be sold.

Manufacturing Cost Estimation

Manufacturing cost estimation represents the complete expenditure incurred when manufacturing an end product. While they do not include all of the indirect costs involved in producing a product, they do represent a comprehensive list of direct expenses involved in creating an item to be sold.

Manufacturing Cost Per Unit

Manufacturing cost per unit is important to monitor. These, in many ways, represent the efficiency of the production process. If labor, material, or overhead costs appear too high then action must be taken. For labor, tools, procedures, or employee numbers must be altered to control cost of keeping employees. In order to maximize productivity of each unit of these materials, materials, procedures and tools must be altered to ensure that the company wastes as little raw materials as possible. When it comes to overhead, company managers must create a working environment which does not exceed the needs it has for production. You must change and balance all of these costs to maximize shareholder value.

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Manufacturing Cost Formula

Use the following equation to calculate the manufacturing cost:

MC = Labor + Materials + Overhead

To find the manufacturing cost per unit formula, simply divide the above results by the number of units produced.

Manufacturing Cost Calculation

Performing manufacturing cost calculations are simple once the essential data is available.

If:
Labor = $100,000
Materials = $75,000
Overhead = $200,000

Then:
MC = $100,000 + $75,000 + $200,000 = $375,000

Manufacturing Cost Example

For example, Austin is the CEO of a plant which manufactures home appliances. Although Austin is experienced in his trade, he has used the experiences former managers have passed on to create a profitable company. He has paid close attention to these managers for a long time and has absorbed their best practices.

Manufacturing Cost Example Calculation

Austin wants to make sure to constantly rotate manufacturing cost saving ideas. To do this, Austin has this calculation performed by his CFO:

If:
Labor = $100,000
Materials = $75,000
Overhead = $200,000

MC = $100,000 + $75,000 + $200,000 = $375,000

Although this amount is completely normal for Austin’s company, Austin would like to bring profits up by pushing his business to the next level. But the problem with this is that Austin already has state-of-the-art tools, computer hardware and software, warehousing, and all other necessary supplies. Austin falls back on what he has learned to find the solution.

Conclusion

As a result, Austin creates a department wide bonus plan to motivate employee efficiency. He then decides that the department which can decrease costs the most will receive a bonus of 5% increased pay each quarter. Additionally, these departments will have a free company lunch once a month as a reward. Austin also makes sure to have his CFO run the numbers to make sure this plan makes financial sense. Then, he begins the plan.
Austin is excited to see what lies ahead. If he can create the proper set of motivations, then he is sure that his employees will love showing up to work every day, just as he does.
If you want to find out more about how you could utilize your unit economics to add more value to your organization, then click here to download the Know Your Economics Worksheet.