Total manufacturing cost: What is it and how to calculate it
Blog //27-10-2021

Total manufacturing cost: What is it and how to calculate it

by Daniel Docherty, Head of SaaS operations

Meticulously keeping track of costs should be a task that is highly prioritised by all manufacturers. If this is done competently, finance teams are in a far better position to assess (and improve) their business’s stability.

But what exactly is total manufacturing cost, and why is it so important for achieving positive outcomes in the manufacturing industry?

In this article, we detail exactly how to calculate total manufacturing cost, highlight some of the different types of costs, and explain the benefits that arise from using this formula…

What is total manufacturing cost?

Total manufacturing cost is the amount of money a company spends on its manufacturing operations, or essentially how much it costs in total to produce the goods that will be sold on to customers.  

As the name suggests, it takes absolutely all spend into account. To attain this information, you’ll need a complete grasp of your product creation process. You should ensure no expense is missed, no matter how obscure or unimportant it may seem. Otherwise, you won’t gain a true representation of outgoings.   

Total manufacturing cost shouldn’t be confused with cost of goods manufactured (COGM) or cost of goods sold (COGS), which are slightly different terminologies. COGM is a formula that only considers the costs associated with items that finished the production process and became sellable products.

COGS calculates the costs of items that not only finished the product creation journey but also got sold to a customer. In contrast, total manufacturing cost (TMC) includes any production costs within a window of time, regardless of what was finished or sold.    

How to calculate total manufacturing cost

In terms of the formula needed to calculate total manufacturing cost, it’s usually expressed in the following way:

  • Total manufacturing cost = Direct materials + Direct labour + Manufacturing overhead

If you have an effective way for capturing the data related to these aspects, then it becomes possible to accurately complete the calculation. Firstly though, you should be certain you know exactly what each aspect means.   

Direct materials are the costs associated with any raw materials that have been directly used in production (and have ended up as one of the core components of the product).  

Direct labour is related to the costs involved in the physical process of product creation, i.e., the labour needed to transform a raw material into a sellable good. This usually consists of the wages paid to employees that are directly involved in production (such as those who assemble items or operate machinery). Any further expense linked to their salary, such as bonuses or tax paid by your company, should also be incorporated into this figure.  

Manufacturing overhead is made up of any other operational costs your business incurs for production to be possible. This would normally include aspects like energy bills and rent, as it’s not possible to create items without power or a physical workspace.

If your machinery suffers breakages or depreciation during this process, you should consider incorporating these financial losses too. Manufacturing overhead also includes the indirect costs that are not part of direct materials or direct labour.  

What is the difference between direct and indirect manufacturing costs?

Direct costs are normally the more flexible expenses that change depending on the amount of production taking place. Whereas indirect costs are usually seen as more constant, as they have perhaps been fixed in advance (such as the overheads mentioned in the previous section).

But what exactly constitutes an indirect cost? In terms of indirect materials, this would be a resource that doesn’t necessarily form part of the finished product. It wouldn’t be visibly obvious as a key part (and wouldn’t be present on a bill of materials). Examples could include glue, water, cleaning product or any other ingredient that has been used at some point during production.

With regards to indirect labour costs, this would be the wages paid to employees that weren’t physically involved with manufacturing, but still played some part in the process. This could be a supervisor, manager, or cleaner, for example (who would be involved with the planning, orchestrating, and maintenance of production).

What are the benefits of total manufacturing cost?

Lower costs

It may seem obvious, but by being aware of all the expenses involved in your manufacturing operation, it becomes more possible to reduce these costs. Total manufacturing costs could highlight expenses that are completely unnecessary (and can therefore be eradicated completely).

It may also shine a light on costs that have, over time, become extortionate without you realising. This newfound visibility around spend could lead to a renegotiation with suppliers, to attain cheaper deals. Or you may research some other potential partners, who can provide you with a better price (whilst supplying you with equally good materials). 

You may also decide to reduce overheads if they’re higher than expected. This could involve searching for a cheaper energy provider or finding a more cost-effective location (where the rent is not quite as high). TMC essentially enables you to improve your spending methods.  

More clarity around financial health

Manufacturers that don’t possess an accurate picture of spend will often have a distorted perception of their financial health, which could cause them to budget poorly. Total manufacturing cost, when compared with income and revenue, provides clarity around profitability and overall business performance.

If your findings in this area aren’t favourable, you can at least use the data as fuel to remedy the situation. This information will dictate key decisions around your company’s direction, such as whether to be cautious or bold (and therefore whether to make cuts or to invest in core functions).        

Informed decisions around pricing

The profitability picture gained from total manufacturing cost will also govern other strategies too, such as your approach to sales and pricing. If your profits are not at the desired level, you may determine that the current sales model isn’t working and that you perhaps need new methods or to open new sales streams (such as e-commerce).

If you conclude that costs are as low as possible, but revenue is still struggling, the next step could be to alter your pricing. If you set prices too high, customers may go to competitors where they can find a better deal. Equally, if prices are too low, you won’t be generating the required revenue to make your business profitable.

A fine balance must be struck, in terms of setting a price that falls within the market norm, but also retrieves an acceptable return (based on the investment that went into producing each good).           

Less waste

When looking at total manufacturing cost, you might not only learn that the materials being bought are too expensive, but also that too many materials are being bought in the first place. By analysing the amount of excess that is usually generated during production, you can use this to adopt a more sparing approach to purchasing.  

This not only has financial benefits but improves your environmental standing too (as you will produce less waste if you only have the materials you need). By having less produce in the warehouse at any given time, fewer storage costs are incurred, and your facility is far more organised as a result. There are some well-known stock control strategies (such as lean manufacturing) that can be utilised to achieve these outcomes.             

Insights that drive efficiency

Actions that reduce costs can often streamline your processes as well. Removing steps from the production process to save money also increases efficiency, ensuring that items are created faster (which leads to greater customer satisfaction).

Another example is sourcing materials from local suppliers. This may lower expenses due to cheaper delivery, but it also ensures a quicker turnaround for your supply chain, making it possible to meet expectations even when last-minute orders are placed.

By searching for more cost-effective machinery/technology, you could stumble upon mechanisms that are far more sophisticated than your previous methods, and therefore provide a much greater ROI (return on investment).  

How can Advanced help with total manufacturing cost?

To work out total manufacturing cost accurately (and to gain the associated benefits), you must have a simple and effective system for capturing all cost-related data. It’s a completely counterproductive endeavour if the information gathered is inaccurate, inconsistent, or outdated in any way. But this is where software can help. 

Our cloud-based Manufacturing Software has dedicated fields to easily keep track of the entire production process, and the related costs too. It has the functionality of both an MRP and a dedicated accounting solution.

Cloud solutions enable you to work from anywhere, at any time, meaning you shouldn’t miss a trick when it comes to spend. But remote access aside, Manufacturing Software’s real strength comes from the fact that it unites all your business functions, allowing every employee to complete work within the same system.

This cohesion leads to powerful data, that can be reported on, analysed, and used for important strategic decisions. It’s much easier to work out total manufacturing cost when the latest financial data can be accessed at the click of a button, and when the information from all departments is inter-connected.   

If you’re looking for a simple and accurate way to monitor total manufacturing cost, whilst also bringing all your business functions together in one place, take a closer look at our Manufacturing Software (which is perfect for small to medium-sized manufacturers).   

 

Blog Manufacturing
Daniel Docherty

Daniel Docherty

PUBLISHED BY

Head of SaaS operations

Daniel joined Advanced in May 2019 to lead our Software as a Service portfolio and brings with him over 15 years of experience in core business and finance solutions, working with customers from a wide background of industries and scale.

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