How to calculate the total manufacturing cost for your business (2023)

Total manufacturing cost combines the direct material, direct labor, and manufacturing overhead incurred in manufacturing inventory. Learn how to calculate this important business metric.

As a small manufacturing business owner, you probably spend a lot of time thinking about thispricing policyand how you can make your manufacturing process more efficient.

Before making decisions about inventory selling prices or changes to the manufacturing process, take a look at your total manufacturing costs. The calculation breaks down your manufacturing costs in such a way that your expenses are easy to analyze.

Overview: What is the total manufacturing cost?

Total manufacturing cost refers to how much a company spent to produce its inventory in a given period of time. The calculation is the sum of threeproduct costCategories: direct material, direct labor, and manufacturing overhead.

Entrepreneurs need to know their total manufacturing costs. Once you know the true cost of your manufacturing, you can be more specificAccount for Inventoryon theirbalance sheetand cost of goods sold on yourproof of income.

It is also an analysis tool. By breaking your manufacturing costs into three areas, you can see where you're overspending and where you should invest more.

Total manufacturing cost is often confused with cost of manufacture (COGM). COGM only counts the cost of inventory that was completed and prepared for sale during the period. The total manufacturing cost includes all costs incurred during the period, regardless of whether the product was fully completed.

How to calculate the total manufacturing cost for your small business

As mentioned above, your total manufacturing cost is the sum of three costs in a given accounting period: direct material, direct labor, and manufacturing overhead.

Total manufacturing cost = direct material + direct labor + manufacturing overhead

1. Direct material

Direct material is the cost of raw materials used in the manufacturing process, which are inseparable from the final product. If your manufacturing company produces screws, the raw material is steel wire, which is procured from a supplier.

Raw materials that cannot be assigned to a specific product or manufacturing run are considered indirect material and are excluded from the direct material cost calculation.

For example, the cost of special oil used in a production machine is considered an indirect material.indirect costsincluded in manufacturing overheads below.

Spoilage or raw material that cannot be used in the final product is to be expected. Unless there is an unusual amount of spoilage, the cost of spoiled raw material is factored into your direct material costing.

When calculating the total production costs, we only take into account the costs incurred in the billing period. For companies using the provisionbilling method, the direct material costs are incurred when the raw material is used, not when it is purchased.

To calculate direct material, compare raw material at the beginning of the year and raw material purchases during the year to raw material remaining at the end of the year. The difference is how much direct material you used.

Direct material = start of direct material inventory + direct material purchased during the period – end of direct material inventory

2. Direct Labor

Direct labor refers to the wages of those who work to manufacture your company's products. Machine operators and assembly line workers are the most common types of direct workers.

For an employee's wages to count as direct labor, he or she must be hands-on in the manufacturing process. Not all factory work is direct labor.

Although essential to the manufacturing process, supervisors and cleaners do not count as direct labor. They are factored into manufacturing overheads below.

Check out oursGuide to the difference between direct and indirect work.

Although there is no direct labor formula to follow, calculating direct labor is the easiest part of the calculation. look at yoursLohnsoftwareand overall thegross wagesof your direct workers for the year.

3. Manufacturing Overheads

Manufacturing overheads are those manufacturing costs that are not direct materials or direct labor.

General costs included in manufacturing overhead include:

• depreciation
• Indirect personnel costs for supervisory, quality assurance and cleaning personnel
• Factory Utilities
• Factory lease or mortgage
• factory supplies

Manufacturing overhead does not include costs incurred outside of inventory production. For example, don't add salaries for accounting and HR staff.

Check out oursManufacturing Overhead Calculation Guide.

4. Analyse

Finally, take a look at your total manufacturing costs and ask yourself a few questions:

• Based on my total manufacturing cost, does my selling price meet my profit target?
• Which expenses are higher than expected? Which are lower? Why?
• How can I streamline the manufacturing process to save cost or time?
• How much inventory will I have at the end of the period? What is the storage cost of holding this inventory?

Answering these questions is the starting point for improving your manufacturing efficiency.

Example of Total Manufacturing Cost

Let's calculate the 2019 total manufacturing cost for Rose Burn, which opened in 2019 and makes and sells rose candles (no relation to actress Rose Byrne).

Start with direct materials. Rose Burn ordered its raw material from a supplier in January 2019.

Direct material costs include taxes and sometimes shipping costs. Image source: author

The company used all of its direct materials to make candles during the year, so the full $17,000 goes into the total manufacturing cost calculation. Note that taxes are included in direct material. Check ourGuide to Shipping Costsbefore adding freight cost.

Now let's get down to direct work. Rose Burn's payroll software shows that four people have worked at the company in the past year. Their names, job titles andgross wageare listed here:

Because Rose and Lily are not part of the candle making process, their gross pay is excluded from the direct labor calculation. Direct labor is Tulip and Daisy's gross wages, totaling $80,000.

We are nearly finished. Go to manufacturing overhead. In this example, we've already encountered a manufacturing overhead: Lily's $50,000 salary. As a production manager, she is not a direct worker, but is nevertheless an integral part of the manufacturing process.

Next we turn to Rose Burn'saccounting software, showing factory lease costs of $60,000:

Factory rent is included in manufacturing overheads. Image source: author

Rose Burn's accounting software shows the following other factory overheads:

• Operating expenses: $45,000
• Equipment depreciation: $5,000
• Other supplies or equipment: $10,000

Rose Burn production overheads are $170,000 ($50,000 manufacturing manager gross wages + $60,000 factory rent + $45,000 operating expenses + $5,000 depreciation + $10,000 inventories).

Add direct material ($17,000), direct labor ($80,000), and manufacturing overhead ($170,000) to get the total manufacturing cost for the year, which is $205,000.

Rose Burn should include this information in the analysis table. How does the company's turnover relate to the total manufacturing costs? What is the inventory at the end of the year? How can we optimize profit? Answer these questions as you build next yearProduction budget.

Total Manufacturing Cost: This is a must for management

Entrepreneurs and managers should keep an eye on the total manufacturing cost of their business. It can provide insights to optimize the manufacturing process.