Tag Archives | manufacturing

Removal Costs

See Also:
Average Cost
Agency Costs
Fixed Costs
Variable Cost
Loan Term

Removal Costs Definition

Removal costs, defined as the costs of removing any physical material from the original location it was placed in, is an often forgotten cost. Despite this, it can have a huge effect on the finances of a company. Major manufacturing plants, businesses with fragile equipment, and multi-national corporations can see removal costs average higher than the entire yearly budget of some small businesses. Though seemingly unimportant, this plays an important role in the irregular fixed or variable costs of many companies.

Removal Cost Explanation

Removal cost, explained in varying importance and detail, remains part of the cost structure of many companies. There are 3 major factors of removal cost: labor, lease on equipment used for the removal job, and spoilage or damage to the material in transit. Removal costs can be a major line item or a minute cost depending on the type of business.

The hadron collider, due to the massive and technical nature of equipment, must make a removal cost estimate and finish work by comparing this to the actual cost of the removal job. On the other hand, the local cosmetics boutique probably never thinks about the removal cost for mannequin and inventory. Still, each of these businesses experience removal costs. In a similar manner, oil companies see removal costs for their platforms in a different light. These businesses may even see these matters as important enough to enact a removal cost management system of it’s own.

Removal costs become more complicated in different environments. In a sterile and empty warehouse, removal costs would be at their minimum. In the very same warehouse, removal costs could skyrocket simply from filling the plant with inventory which then must be worked around. Under water, in mountainous regions, and other unique terrain removal costs play an important role. One day businesses could even deal with removal costs of items in space.

Removal Cost Example

For example, Kyle owns a large distribution warehouse for oilfield equipment. His warehouse has been running for quite a while and works on a tight operations schedule. Kyle, the founder and CEO of the plant, has faith in his decision making abilities.

Kyle has found a property which will serve as a more efficient warehouse. The facility is well maintained, closer to major transportation routes, and being sold at a discounted price. Kyle decides to make the switch and prepares his employees to move.

In this project, Kyle must move inventory, inventory storage and accounting equipment, offices, and more. He sees this as a minor setback to his operations which will pay off in the end.

Kyle and his team work diligently and are nearly completed with their move. Now, the only items left are the inventory storage racks. Kyle is just about to begin when his company CFO rushes out of the office to speak with him.

Surprising News

His CFO shares surprising news: moving these racks is a poor financial decision. Kyle, skeptical of this, wants to see the proof.

Liam, the CFO, shows his work. The removal cost of the inventory storage system will cost approximately $12,000 for a plant of this size. To put things in perspective, the racks have already become fully depreciated. Liam knows that the plant, even though it is being sold, will still need storage when the new tenant moves in.

Liam, through his contacts, was able to find an inventory storage system for $14,000. Though this is more expensive than the removal cost, the item will be shipped for free. On the other hand, Liam also knows the real estate market for warehouses. A new purchaser of the property will need an inventory storage system just as Kyle did. This, along with other benefits of this property, will be of persuasive value in selling the property. His calculation, based on expertise, places this negotiating power to increase total property value by $20,000. It seems many warehouse owners have the same concerns and hassle as Kyle when they decide to move.

Conclusion

Kyle remains skeptical until Liam completes his explanation. In a persuasive manner, Liam lays out the details of the plan. On the downside, Kyle’s plant could loose $2,000. On the upside, however, Kyle’s plant can make $20,000. Kyle decides to run with the plan that Liam has carefully formulated. Kyle is pleased with Liam’s work and will treat him to an expensive steak dinner for catching the mistake before it happened.

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Product Costs

See Also:
Economic Production Run (EPR)
Product Pricing Strategies
Bank Charge
Completed Production Method
Inventory Shrinkage

Product Costs Definition

Define product costs as the total costs of creating products, is an essential factor in the success of a manufacturing business. Some of these components include all direct costs, from raw materials to labor and even transportation, included in creating a finished product ready for sale.

Product Cost Explanation

Explain product cost as the entire cost spectrum for a product, can have varying levels of complexity. The product cost concept will vary greatly depending on the type of product produced.

For a simple injection-molded plastic product, product cost per unit will include raw plastics, transportation from the raw material maker to the manufacturing plant, labor, energy used by manufacturing machines, and more.

For a software product maker, a product cost breakdown will include development labor, energy, and any other costs directly associated with making the piece of software.

Any business which makes products has a product cost. To assure efficient and profitable systems it is in the best interest of the business owner to monitor these costs. From this information a company can solve internal problems and ultimately increase the company’s bottom line (Revenue – Costs = Profit).

Product Costs Formula

No single product cost formula seems to exist. More, it is the combination of all of the costs which add up to create a product. This can widely vary based on industry, production method, and more.

An industry average may be available to perform product cost analysis as compared to standard practices. This way, a company can see if they are meeting common standards. From here a company can attempt to become more efficient than the industry standard by enacting some best practices.

Product Cost Example

Sterling is the owner of a web development company. Though he works with intangible assets, mostly, he still has a product cost equation. His product cost effects his bottom line as much as any manufacturing firm.

On average, Sterling charges clients $10,000 for a perfect web application which is ready to be deployed. In comparison, it usually costs him about $3,000 to create one of these applications. Sterling would like to reduce this in order to increase company profits.

Sterling looks at his main factor: labor. By hiring better developers Sterling will slightly increase labor costs but also expects the developer to produce 10% more in one hour than his current employees.

On the other hand, by purchasing new development software Sterling expects to also increase average worker productivity by 10%.

Choosing An Option

In this example, Sterling will choose an option based on his preferences. Rather than interviewing an entire new team he opts for the new system. This way he will not have to waste time, energy, and create a hassle for his current employees. He chooses this option after speaking with his CFO, who informs him that the cost of the new system will be virtually the same as the cost of hiring new employees. Specifically, the software will cost a total of $160,000. He will have to spend $159,500 on project manager time, new employee training, and processing.

Sterling is confident that he has made the right decision. He looks forward to his new software and the happy faces of the employees he appreciates.

To learn how to price for profit, download our Pricing for Profit Inspection Guide.

Product Costs

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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.

Manufacturing Cost

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Make-or-Buy Business Decision

See Also:
Company Life Cycle
Market Positioning
Marking to Market
Mining the Balance Sheet for Working Capital
Inventory to Working Capital

Make-or-Buy Business Decision

Make-or-buy decisions arise in business when a company must decide whether to produce goods internally or to purchase them externally. This typically is an issue when a company has the ability to manufacture material inputs required for its production operations that are also available for purchase in the marketplace. For example, a computer company may need to decide whether to manufacture circuit boards internally or purchase them from a supplier.

When analyzing a make-or-buy business decision, look at several factors. The analysis must examine thoroughly all of the costs related to manufacturing the product as well as all the costs related to purchasing the product. Such analysis must include quantitative factors and qualitative factors. The analysis must also separate relevant costs from irrelevant costs and look only at the relevant costs. The analysis must also consider the availability of the product and the quality of the product under each of the two scenarios.

Identify the “destroyers” of value that can impact your company’s value. Click here to download your free “Top 10 Destroyers of Value“.

Quantitative vs. Qualitative Analysis

The make-or-buy decision involves both quantitative analysis and qualitative analysis. You can calculate and compare quantitative considerations. Qualitative considerations require subjective judgment and often need multiple opinions. Also, some of the factors involved can be quantified with certainty, while other factors must be estimated. The make-or-buy decision requires thorough analysis from all angles.

Quantitative factors to consider may include things such as the availability of production facilities, production capacity, and required resources. They may also include fixed and variable costs that can be determined with certainty or estimated. Similarly, quantitative costs include the price of the product under consideration as it is being priced by suppliers offering the product in the marketplace for sale.

Qualitative factors to consider require more subjective judgment. Examples of qualitative factors include the reputation and reliability of the suppliers, the long-term outlook regarding production or purchasing the product, and the possibility of changing or altering the decision in the future and the likelihood of changing or reversing the decision at a future date.

Relevant Costs and Irrelevant Costs

When making the make-or-buy decision, it is necessary to distinguish between relevant and irrelevant costs. Relevant cost for making the product are all the costs that could be avoided by not making the product as well as the opportunity cost incurred by using the production facilities to make the product as opposed to the next best alternative usage of the production facilities. Relevant costs for purchasing the product are all the costs associated with buying it from suppliers. Irrelevant costs are the costs that will be incurred regardless of whether the product is manufactured internally or purchased externally.

After you’ve identified the relevant costs and irrelevant costs in your company, download the free Top 10 Destroyers of Value whitepaper to learn how to maximize your value.

Make-or-buy business decision

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Maintenance Contract

See Also:
Progress Billing for a General Contractor
Completed Contract Method
Covenant Definition of a Bond Contract
How to Maintain an Effective Job Schedule
Accounting Cycle

Maintenance Contract Definition

A maintenance contract, defined as the contract between 2 parties which creates the agreement that one party will maintain an asset owned by another party, is common across many industries. Maintenance contracts can exist for equipment, a building, landscape, computers and other information technologies, and more.

Maintenance Contract Explanation

A maintenance contract, explained as an agreement which supports many service businesses, is simply an agreement to maintain something. This addresses the many needs listed above, Additionally, a maintenance agreement can span across multiple industries. For example, manufacturing has equipment which needs to be maintained just as much as healthcare, IT, retail, and more. A maintenance contract signifies the agreement to maintain anything and is somewhat of a general concept.

Common parts of a maintenance contract span across all needs. A maintenance contract agreement sets the expectations, timeline, requirements, price, and what is not included in the contract. The two invested parties usually negotiate the annual maintenance contract rules. Then, they finalize it with a maintenance contract form.

Initially, it is presented in the form of a maintenance contract proposal. This, the initial document, is similar to a proforma invoice. It is merely a quote. After negotiation the final agreement is made official with a contractual document.

One will want to pay special attention to the maintenance contract terms and conditions. Through these, agreements may be made which were not necessarily agreed upon. A business can only understand what they are agreeing to when they fully read and understand the contract. Ask your lawyer to read the contract before it is signed if you need help.

Generally, you need a maintenance contract cancellation letter to end an agreement. This document officially ends the relationship between the two parties. Before sending one of these letters, allow the customer to tell you how their expectations are not being met. By doing this, you are being professionally courteous. If the problem persists, you can formally close the agreement with a cancellation letter.

Maintenance Contract Example

Lisa is the owner of a property maintenance firm. Following in her father’s footsteps, she works diligently to maintain the apartments and other real estate properties which have created her livelihood. You can find Lisa often “putting out fires” as the founder of her business.

Lisa has no small task ahead of her. In fact, she has a large one. She must convince one of her customers who recently cancelled service to send her a maintenance contract renewal letter. As the owner of her business, she is the head saleswoman and customer service representative.

When this customer cancelled his services, it surprised her. This was because he never spoke to her about any issues. Upon speaking with him, she realizes that he has found a better price. She must start negotiating quick before she looses this account.

Instead of creating a price war she relies on her ability to satisfy her customers. She agrees, with the customer, to have a single associate dedicated to his account. She can provide this by hiring a part time college student. This person will provide the custom service that many other companies, especially mass market companies, can not.

As a result, Lisa is able to keep the client she was trying to save. She is thankful that she was able to meet his needs. If she creates positive word of mouth, then she can receive the referrals that her company can convert to customers. Over time, this will create the success she deserves.

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Indemnity Clause

See Also:
Blue Sky Laws
Tips on How to Manage your Lawyer
Steps to Track Money In and Out of a Company
Accounting Asset Definition

Indemnity Clause Definition

The indemnity clause definition is the clause which compensates either party in a contract against loss. It is one of the most common ways for a party to mitigate the risk of a contract. Indemnity clause contracts provide repair, replacement, or payment for an indemnitee from an indemnitor.

Indemnity Clause Meaning

The indemnity clause meaning is a protection to one or both parties in a contract in the event a loss is incurred. Lawyers often refer to the concept as the “indemnity lottery”; though an indemnity clause in contract exists the outcome of said clause is still uncertain. Despite this, indemnity clauses are often included in contracts where one party has a distinct chance of experiencing loss as a result of problems with the transaction. Additionally, an indemnity clause hold harmless agreement exists to displace the damages of one party from another.

Indemnity Clause Example

Maggie is an experienced lawyer. Working with commercial clients, her hard work and attention to detail have created mutually beneficial outcomes for both her and her clients. She is hoping to achieve another one of these outcomes while finalizing a contract for one of her clients today.

Two Party Contract

The contract is for two parties: a car manufacturer and a car seller. Maggie represents the car seller. In the contract, Maggie writes the details of how to sell the vehicles and ship them from the car maker to the car seller. She also writes an indemnity clause in contract for the car seller to ensure that they will be met with fair compensation if the product is lost.

She completes this contract, then the consul representing the manufacturer reads it. Then both parties signs it. As she is doing other work, Maggie receives a call about the contract. It seems her client, the seller of cars to individual customers, has not received the vehicles. This was caused by a delayed at the manufacturing plant. In this call Maggie is thanked for including an indemnity clause in transfer because it covered the loss of income in the business. This business is a small company which needs consistent operations to meet the needs of their expenses.

Once again, Maggie helped another client. She vows to use her expertise to help her clients, as well as herself, for as long as she can.


Is it time to hire a CFO? Click to learn the 4 reasons why it may be time to hire a CFO. 

Indemnity Clause, Indemnity Clause Definition, Indemnity Clause Meaning

 

Indemnity Clause, Indemnity Clause Definition, Indemnity Clause Meaning

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Labor Costs

See Also:
Absorption vs Variable Costing
Agency Costs
Operating Capital
Replacement Costs

Labor Costs Definition

The labor costs definition is the total cost of all labor used in a business. It is one of the most substantial operating costs. These are particularly important in any business which experience heavy human resource labor costs: construction, manufacturing, and other industries which have partially or non-automated operations. These costs include 2 main subcategories. The direct labor costs definition is summarized as the cost of labor which is used directly to make products. Meanwhile, the indirect labor costs definition is simply explained as the cost of labor which is used to support or make direct labor more efficient.

Labor Costs Explanation

These costs are explained by many as the most important cost a company will face, is a key factor in almost any business. This is due to the fact that employee turnover is one of the main factors which causes a business to fail. To begin, it is in the best interest of any owner that unit labor costs and inflation are minimized to maximize profits.

The importance of labor costs does not stop here. They are a variable cost. As such, they must also occur in a predictable cycle to avoid cash flow problems. If a firm is seasonal and requires additional labor at peak times, business controllers must have the cash on hand to afford this increase in cost. If a business plans properly it will avoid many cash issues associated with the cost of labor.

Labor Costs Formula

A single formula will not serve the many different needs associated. Despite this, a common and simple formula is included below:

Labor Costs = (total sales x labor %) / average hourly rate of labor

Labor Costs Calculation

To perform a simple labor costs calculation follow the process outlined below:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

Labor Costs Example

For example, Leann is the owner of a clothing store in the largest mall in her city. Leann, a fashion aficionado from birth, knows the popular styles better than any designer in Milan. She works diligently to make sure her store stays in pace with the trends of today as well as the future.

Leann is gearing up for her peak season. Additionally, she is concerned because her off-season sales have slumped slightly. She sees the new season as a great opportunity to move inventory and regain the ground. That is, if she has enough cash to get by.

Leann will need to increase hours for sales and backroom staff during these peak times. To balance that, she will also have to make sure she can pay for these employees. The slump in her off-peak season has made Leann plan more for the future. She now wants to calculate cost of labor for her peak period to make sure she can afford the cash needed to get by.

Example Calculation

Leann performs this simple calculation to find her cost of labor:

If:
Total Sales = $1,000,000
Labor % = 15%
Average hourly rate of labor = $10

Then:
Labor Costs = (total sales x labor%) / average hourly rate of labor
Labor Costs = ($1,000,000 x .15) / $10 = (150,000) / $10 = $15,000

For Leann’s retail business cost of labor total $15,000 for the period she is studying. This is more than she expected and can afford. Luckily, Leann has excellent credit. Leann decides to apply for a small business loan to help her company survive the first month of peak demand. From here she will make the cash necessary to continue.

Leann also decides to pay more attention to her company finances. She was not surprised by this situation, but still wants to be able to predict the problems that her business will face better. Her drive and insight will achieve this and many future goals.

If you want to increase the value of your organization, then click here to download the Know Your Economics Worksheet.

Labor Costs, Labor Costs Definition

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