What is product cost?
It’s important to know the manufacturing cost of your products. This is one of the most significant and defining factors in any manufacturing business.
The sales price is the value the company receives for making the product. The key question is – at what cost does this come? If the cost is higher than the value, the company is losing money; if the cost is lower, it’s making money.
The product cost is made up of three main components:
- Material cost – price paid for all the materials used in the product.
- Manufacturing overhead – costs associated with operating the machinery and running the factory.
- Labour cost – the wage workers are paid for making the product.
Having a clear understanding of the cost will provide important input for making decisions by answering many questions, for example:
- Does the product really cost what you think?
- Why does it cost that amount?
- How much profit is the company making off this product?
- Which cost components need improvement, if any?
- What direction should the sales price change, if any?
- In what direction should the cost or profit move?
Standard cost accounting
In the 1920s, the Standard cost accounting method was introduced. Simply described, it works as follows:
- In the beginning, company estimates the cost of products (this is a Standard cost).
- After some period, company calculates actual costs.
- Actual costs are compared to standard costs; the difference is called a e. varianc
Knowing variances allows for analyzing efficiency, improving estimations and making better quotations.
The Standard cost accounting method was good enough when the world was slower, competition was not as tough, prices were not so volatile and product life cycle was longer. Nowadays, this method has several drawbacks:
- Standard costing uses methods that do not give as precise costs as possible.
- Feedback is relatively slow.
- When variances arise, it is difficult to find the source.
Modern technology – that is, Manufacturing Resource Planning (MRP) – allows for more precise calculations and better estimations.
Product cost calculation in MRPEasy
In MRPEasy, product costs are calculated with great accuracy:
- The cost of materials used in the creation of a product is calculated.
A document, called Bill of Materials, is used to list all the materials used in the making of the product.
The cost of all reported materials used in production is calculated, which makes handling even special situations easy; e.g. in a situation where materials are consumed in excess.
- The manufacturing overhead is calculated.
A document, called Routing, is used to define all production operations, times and costs and assigns these to specific work stations. If there are several work stations of the same type, each can have a different time cost, which will be considered.
- The labour cost is calculated.
Each workers’ wage is defined and the labour cost is calculated based on time reported working on every operation, or quantity reported produced.
Even before production begins, it is simple to accurately estimate the cost of the product. Once production is completed, the exact cost of the product is known.
Finally, in the CRM section, and in the Statistics tab, there are many reports, which will clearly show the cost structure along with profit/loss information. For example, you can easily check which products sold were the most profitable last month, which customers bring you the most revenue, etc.