How to Calculate Total Manufacturing Cost

Does the task to calculate the total manufacturing cost fill your heart with dread? Once the complete realm of accountants and productivity engineers, the total manufacturing cost has now been revealed as an approachable useful tool for organizations of all sizes and types.

But the busy manager doesn’t have to swap on their accounting hat to understand what needs to be done, they can simply use the below formula to get a grasp on the ins and outs of their firm’s production pipeline.

Additionally, the total manufacturing cost can be highly useful for managers or investors to compare to total revenue to quickly understand a firm’s profitability.

What exactly is the total manufacturing cost?

Simply put, the total manufacturing cost is the total sum of a budget that is needed to complete production during one financial period. Or in plain terms the cost to make products during a period of time.

To break it down, it is comprised of three key areas:

  • Direct Materials
  • Direct Labor
  • Firm Overhead

Each added together will create the total manufacturing cost:

Total Manufacturing Cost = Direct Materials + Direct Labor + Firm Overhead

Notice that this formula does not take into account the quantity of products produced, but only the overall cost to manufacture all the units required during the time period.

Direct Materials Cost

Direct materials are the actual physical materials that need to be purchased, refined and consumed to make the product.

Without the MRP software, it is needed to calculate, how much raw materials the firm has on hand in inventory, then add the total cost of new purchases of direct materials made during the financial period, minus the ending inventory of direct materials at the end of the financial period.

Cost of direct materials = Beginning inventory (Before) + Purchases added (During) – Ending inventory (After)

As you can see, to get the total cost of consumed materials, it is needed to perform a stocktaking and to sum up all invoices for materials.

Further more, not all materials get turned into products. There are two outcomes for materials, consumption into a product and scrap (materials that are in excess and unusable after a product has been created).

This does not include any materials that are consumed to make the product that is ‘not inherently part of the product’. For example, water in a soft drink is part of the finished product and thus a direct material. Conversely, water to wash the equipment is not.

MRP software can calculate the direct materials cost by summing up materials costs of manufacturing orders that were executed during the period, thus eliminating the need to perform complex calculations.

Direct Labor Cost

Of course, products are more than just the sum of their materials, a firm will need to invest resources (specifically labor) in turning the direct materials into finished goods.

A staff member might work on a production line, or perhaps it’s a manager who overseas some complex machinery (Not the maintenance of the machinery, just the operator).

It is important to include any retirement funds, holiday pay, payroll taxes or additional fee’s that are incurred by paying direct labor. This does not include support staff (HR or Accounting, that is not included in the total manufacturing cost), only the direct labor who create the product, and the process that pays them.

This cost is calculated on the same financial period as the direct materials.

Firm Overhead Cost

The last piece of the puzzle is the firms overhead. This is everything from the electricity to the maintenance and depreciation of equipment.

Here is a brief list that will give a good overview of what items to consider:

  • Machine running costs (Electricity, water*)
  • Maintenance cost
  • Depreciation of equipment
  • Quality inspecting the final product.

Overhead does not include administration wages, sales, marketing, office rent or other staff salaries.

Putting it together

With these three items discovered, a firm can then simply calculate the total manufacturing cost.

Total Manufacturing Cost = Direct Materials + Direct Labor + Firm Overhead

With this figure, a manager can remove the total manufacturing cost from revenue to understand the relationship between manufacturing, profit and sales.

Naturally, this total manufacturing cost does NOT include the costs associated with ‘doing business’. Marketing, HR, accounting and administration is not included in the total manufacturing costs. An argument could be made that administration labor is spent on overseeing manufacturing (such as plant visits) or developing new products but if desired it should be added into the final result with caution.

For managers that come up with a cost of goods sold that is higher than the total manufacturing cost, then resources from other financial periods are being consumed. You cannot make something from nothing.

Naturally a digital product may not have much in the way of direct materials, but still has direct labor and overhead to produce.

To keep better track of your direct materials and quickly calculate total manufacturing cost, a manager would be wise to invest in technology such as MRPeasy, a cloud-based MRP software designed for enterprises that want to be lean and efficient.

* If water is an essential part of a product, such as a beverage, then it is a direct material cost, not an overhead cost