Manufacturing cost – how to know it?
Knowing manufacturing cost is extremely important in order to offer competitive prices while staying in profit. To complicate the matter, the word cost shelters two different concepts:
- before manufacturing, cost is only an estimation that is used to make a quotation (which will become an obligation if customer confirms the order); or
- after manufacturing, cost is a very precise monetary value that is needed for business analysis and accounting.
Furthermore, calculating manufacturing cost is trickier than figuring out service or wholesale businesses’ costs. Even if we omit research and design, manufacturing cost still consist of at least three components:
- material costs (not applicable in case of service),
- labor costs; and
- production costs (not applicable in case of wholesale).
And the initial estimate of each of the three components (i.e. the basis of a quotation) may change until the manufacturing is fully finished.
How to estimate manufacturing costs?
First of all, you need to create a list of required parts with their quantities and costs (Bill of Materials or BOM). Secondly, you should create a list of required operations to produce the final product and estimate the length and cost of each operation (this list is called Routing). Based on the routing you can calculate labor costs. Summing up all these values in the BOM and the routing gives you the estimated cost of the final product. (Learn more about why to use MRPeasy BOM Software)
Is this value precise?
Unfortunately, the answer is maybe. In the case of manufacturing, costs can always go over the quota (more materials consumed, more time spent, etc.) thus making the project unprofitable.
How to fight this problem?
The only option is to add some buffers that would cover unexpected expenses. Yet the buffers must be reasonable in order not to raise the selling price too high. The only method that allows you to choose valid buffers is analysis: after manufacturing has started, all costs must be documented and compared to initial estimations. If this is done, after several projects, you have enough experience to choose the appropriate buffers.
To sum up, initially idea behind the word cost seems to be a very simple thing. However, in reality getting a manufacturing cost that is applicable for a real business is a complex task and should be perceived as a continuous process.
Also read this comprehensive article on Total Manufacturing Cost.