How to Calculate Total Manufacturing Cost?
Total Manufacturing Cost is an essential metric for understanding the productivity and profitability of a business. Among other things, it can be used to adjust the selling price of your products and to identify and cut unnecessary expenses.
What is Total Manufacturing Cost?
Total Manufacturing Cost is the total sum that has been spent on production activities during one financial period. Or in plain terms, it is the cost of manufacturing products.
Once the complete realm of accountants and productivity engineers, the Total Manufacturing Cost has now been revealed as an approachable and useful tool for organizations of all sizes and types.
It is an essential metric for understanding the productivity and profitability of a business. Managers or investors can compare the Total Manufacturing Cost to total revenue and get a quick overview of the company’s profitability. Companies can adjust the selling price of their products by analyzing the Total Manufacturing Cost. Additionally, knowing where your money is spent gives you the chance to identify and cut unnecessary expenses, thereby streamlining your manufacturing business.
Luckily, the busy manager doesn’t have to complete an accounting course to understand what needs to be done. They can simply use the guide below to get a grasp of the ins and outs of their company’s production pipeline.
Read more about Calculating the Selling Price of Your Products.
How to calculate Total Manufacturing Cost?
The Total Manufacturing Cost consists of three key business costs:
1. Direct material costs
2. Direct labor costs
3. Manufacturing overhead costs
Let’s dive deeper into these three areas.
Direct material costs
Direct materials are the actual physical materials that need to be purchased, refined, and consumed in order to make the product. Keep in mind that direct materials are only those that are used in a significant, measurable quantity, i.e. the materials that are included in the bill of materials of a product.
Indirect materials are generally used in many types of products, in insignificant quantities per unit. These materials are accounted for in the manufacturing overhead.
For example, in a furniture manufacturing company, timber, paddings, and textile are the direct materials used in production. Glue, nails, sandpaper, etc. are indirect materials.
In a beverage company, water would be used as a direct material that goes into the bottle. But water could also be used as an indirect material to wash the bottles or equipment. It is necessary to keep these types of consumption separate for accounting purposes.
You can calculate your direct material costs by adding the cost of raw materials purchased to the beginning raw materials inventory, then subtracting the ending raw materials inventory.
You cannot just take the number of products manufactured and multiply it with the material quantities going into each product because you also need to account for Work in Process inventory, waste, and scrap. That is why raw material inventory and material purchases are used to calculate the Total Manufacturing Cost.
If you do things manually, with pen and paper, or spreadsheets, you will need to perform regular stock-takes and sum up all invoices for materials to get the numbers right.
ERP/MRP software, however, can calculate the direct material cost by summing up material costs of manufacturing orders that were executed during the period, thus eliminating the need to perform complex calculations.
Direct labor costs
Products are more than just the sum of their materials. Much of a manufacturing company’s resources are allocated towards labor that turns the direct materials into finished goods.
The direct labor costs that go into calculating the Total Manufacturing Cost are only incurred from staff that are directly involved in the production part of the business, e.g. line workers, craftspeople, machine operators.
Staff that are not handling the production of goods, such as management, accounting, maintenance, cleaning staff, etc. are not considered direct labor.
Note that it is important to include retirement funds, holiday pay, payroll taxes, or any additional fees that are incurred by paying direct labor. Some companies may also decide to include costs related to training the production staff.
MRP software can calculate the direct labor cost by summing up reported work hours of manufacturing orders that were executed by workers and multiplying it with their wages, thus eliminating the need to perform complex calculations.
Manufacturing overhead costs
The last piece of the puzzle is the overhead. This comprises everything from the electricity used to the maintenance and depreciation of equipment.
Here is a brief list that will give you a good overview of what items to consider:
- Production facility rent/mortgage
- Production facility utilities (electricity, water)
- Indirect materials used in production, other production supplies
- Indirect labor costs related to production such as production supervisors, quality assurance, and shop floor cleaning staff
- Maintenance costs
- Depreciation of equipment
Manufacturing overhead does not include administration wages, sales, marketing, office rent, or other staff salaries.
Normally, manufacturing overhead costs are only clear after a financial period is over, and products long sold. ERP/MRP software can also pre-apply the manufacturing overhead costs to your products according to an estimated rate. This gives a better insight into cost and profit in real-time, without having to wait until the financial period end, and thus helps you to price your products better. At the end of an accounting period, you can compare if the overhead was under- or overapplied and adjust the rate accordingly.
Read more about Applied Overhead vs. Actual Overhead.
Total Manufacturing Cost formula
To find the Total Manufacturing Cost, just add together the aforementioned three key costs from the specified financial period.
Therefore, the Total Manufacturing Cost formula is this:
Total Manufacturing Cost = Direct Materials + Direct Labor + Manufacturing Overhead
At the start of a quarter, a furniture manufacturing company has $8,000 worth of raw materials waiting in inventory. During the period, $5,000 worth of stock is added to the raw material inventory. At the end of the period, however, there remains only $3,000 worth of raw materials. Using these numbers, we can calculate the Direct Materials used.
Direct Materials = $8,000 + $5,000 – $3,000 = $10,000
There are eight shop floor workers in the company that are directly involved in production. Four of them have seniority and/or special skills and make $2,600 a month, the other four make $2,200 a month. The sum of their quarterly pay is the Direct Labor Costs.
Direct Labor = [($2,600 x 4) + ($2,200 x 4)] x 3 = ($10,400 + $8,800) x 3 = $19,200 x 3 = $57,600
The Manufacturing Overhead is composed of indirect labor costs for maintenance (wages amount to $9,000 in a quarter) and warehouse (wages $12,000 in a quarter), additional materials such as glue and sandpaper ($800), rent ($6,000 per quarter), insurance ($200 per quarter), and an equipment depreciation of $2,400 a year, i.e. $600 per quarter. That is $28,600 altogether.
Manufacturing Overhead = $28,600
So, the Total Manufacturing Cost for the quarter is the sum of the direct material and labor costs, and manufacturing overhead.
Total Manufacturing Cost = $10,000 + $57,600 + $28,600 = $96,200
Total Manufacturing Cost vs. COGM vs. COGS
Total Manufacturing Cost is often conflated with the Cost of Goods Manufactured and the Cost of Goods Sold, which both are separate concepts as well. Even though all of these terms are related, it is necessary to know their difference.
While the Total Manufacturing Cost shows how much money was spent on all production activities, COGM details the costs related only to the production of those goods that were finished during the period. This means that unfinished products that were transferred into Work in Process inventory are left out of the sum. When all production has finished, however, the TMC and COGM are equal.
COGS, however, accounts only for those finished products that were sold during the financial period.
As seen above, the Total Manufacturing Cost is the sum of three key costs:
- Direct Material Costs
- Direct Labor Costs
- Overhead Costs
The Cost of Goods Manufactured uses the Total Manufacturing Cost as a component in its own formula. However, as COGM shows how much was spent on manufacturing finished goods, we have to count out the WIP that was started during the period.
So, the COGM formula is this:
Subsequently, COGM is used to calculate COGS. While COGM shows the costs related only to producing finished goods, COGS is the cost of only those goods that were sold. When all of the finished goods have been sold, then COGS is equal to COGM.
This is the COGS formula:
Using the Total Manufacturing Cost
Taking a look at your Total Manufacturing Cost is an important step when trying to make your business more cost-effective. While COGM and COGS are strictly accounting terms, Total Manufacturing Cost is also used to identify areas in the production process that need to be streamlined.
- Comparing the Total Manufacturing Cost with your total revenue gives you an insight into your company’s profitability. If you find that your profits are lower than expected, you can either review the selling price of your products or find areas where costs can be cut.
- Analyzing the Total Manufacturing Cost shows you which expenses were higher than expected, and which were lower.
- As mentioned, the Total Manufacturing Cost is used to calculate the Cost of Goods Manufactured and the Cost of Goods Sold, which are essential areas of manufacturing accounting.
All of these aspects are important when trying to improve your manufacturing efficiency.
Total Manufacturing Cost in an MRP system
Along with many other manufacturing accounting metrics, the Total Manufacturing Cost can easily be tracked in an MRP/ERP system. Using this kind of software with a built-in manufacturing accounting system allows you to reduce the workload of managers and accountants, freeing up time to put into activities that help actually grow the company.
In a robust MRP system, production costs can be tracked per period, per project, or per product, making it suitable both for job shops and make-to-stock manufacturers.
- Total Manufacturing Cost is the total sum that has been spent on production activities during one financial period. As such, it is an essential metric for understanding the productivity and profitability of a business.
- The TMC consists of three key parts: direct material costs, direct labor costs, and manufacturing overhead costs.
- Direct material costs are the costs of materials that can be quantified per product, i.e. materials that are part of the BOM.
- Direct labor costs are costs related to the salaries of employees directly responsible for production, i.e. line workers, craftspeople, machine operators, etc.
- Manufacturing overhead is overhead directly related to the production of goods. This includes production facility rent/mortgage, utilities (electricity, water), indirect materials used in production, indirect labor costs related to production, maintenance costs, depreciation of equipment. Manufacturing overhead does not include administration wages, sales, marketing, office rent, or other staff salaries.
- The Total Manufacturing Cost is also used to calculate the Cost of Goods Manufactured (COGM) and the Cost of Goods Sold (COGS).
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