Before you can set a price for any item you manufacture, you must calculate the per-unit manufacturing cost. This product cost calculation includes elements such as the cost of raw materials, direct labor, and overhead costs. The price you set determines your profit margin.
Define Total Manufacturing Cost
The accounting and business term, total manufacturing cost, also called cost of goods manufactured, which shows up in the cost of goods line in the income statement, which encapsulates a company’s expenses across departments during the three stages of the manufacturing process:
- raw materials,
- finished products.
It provides a detailed accounting for the costs of labor, materials, and overhead costs.
Total Manufacturing Cost Formula
While many math formulas used in finance and business require complicated arithmetic, the total manufacturing cost formula does not.
The formula is: Total manufacturing cost = raw materials + direct labor + manufacturing overhead
While direct labor cost and cost of manufacturing overhead remain a straightforward calculation of summing, the cost of raw materials, also referred to as direct materials cost, used in the total manufacturing cost calculation requires a formula as well.
The formula is: Cost of raw/direct materials = Beginning inventory + Purchases added – Ending inventory
How to Calculate Total Manufacturing Cost
The simplicity of the formulas belies the work behind calculating them. Your first step, calculating the total cost of direct materials used in the manufacturing purposes, entails an analysis of construction, so you include the cost of each nut and bolt. Determine the actual cost of each component of raw materials required to manufacture the finished product. Sum these expenses for the raw/direct materials component of the equation. Second, calculate the total cost of labor that contributes directly to the manufacturing process. This includes salaries, wages, incentives, and benefits. Third, you calculate the total cost of manufacturing overhead, which takes into consideration indirect costs such as indirect labor and indirect materials, utilities, repair and maintenance costs, taxes and insurance, depreciation, and stolen assets.
Total Manufacturing Cost Per Unit
You must set a finite period during which you calculate the total manufacturing costs. Typically, this is a fiscal quarter. Once you calculate the total cost, you divide that value by the number of items manufactured during the same period.
Per Unit Cost = Total Manufacturing Cost/Total Number of Items Manufactured
This provides you an easily understood number to work with to set your asking price, also known as the manufacturer’s suggested retail price, for your product. Comparing the total manufacturing cost to the total revenue generated lets you easily see your company’s profitability. This one simple calculation aids you in multiple ways in your business accounting.
Why is the Calculation of Total Manufacturing Costs Important?
Monitoring the company’s financial statements is critical as owners can analyze the manufacturing cost as a proportion of total sales between accounting periods. Knowing this, management can then look to cost cost-cutting measures to improve profitability.