Manufacturing business owners spend a great deal of time perfecting their pricing strategies to increase profitability. Several factors can influence the pricing strategy of a manufacturing product, including the manufacturing process, cost of labor, and raw materials. Deciding on the selling price is an important decision that business owners need to make during the product development cycle and may often need reevaluating as and when needed. Taking a closer look at the manufacturing cost can help you decide on your products’ selling price.
What is manufacturing cost?
Manufacturing cost is the amount of money that a company must spend to produce its inventory. To calculate the manufacturing cost of a product, you would need to know the cost of:
- Direct material
- Direct labor
- and manufacturing overheads.
Categorizing the cost into these heads helps you lower your production costs by identifying where you are overspending. For example, a high manufacturing overhead could indicate an opportunity to optimize your production process by making it more efficient.
How to Calculate Manufacturing Cost
We’ve discussed manufacturing cost, so next, let’s learn how to calculate it.
Step 1. Direct materials cost
To know your cost of materials, you would need to know your starting inventory value, how much inventory you purchased, and your ending inventory value. Once you have these three figures at hand, you can easily calculate your cost of materials using the formula:
Direct materials cost = Starting inventory value + Purchases – Ending inventory value
You can use our free cost of goods calculator to calculate your direct material cost.
Step 2: Cost of labor
To calculate the labor cost, add all labor wages, payroll benefits, and taxes compensation paid to employees directly involved in producing the product. The labor cost must not include salaries for executives and other personnel not directly involved with the production.
Step 3: Overhead costs
Overhead costs are indirect production costs, such as rent, electricity, and the cost of keeping running production-specific equipment, including their maintenance. Remember that overhead costs must not include general and administrative expenses such as advertising, storage, and shipping.
Step 4: Manufacturing cost Formula
To determine manufacturing cost, simply add the direct materials cost, cost of labor, and overhead costs you’ve calculated in the steps above.
Manufacturing cost = Direct materials + Direct labour + Manufacturing overheads
Example of manufacturing cost
Let’s take the example of a company ABC Watches Inc, involved in manufacturing watches. Now, let’s calculate the manufacturing cost of a single unit of their best-selling watch.
- Direct materials: $10.50
- Cost of labor: $26
- Overhead costs: $2.50
Manufacturing cost = $10.50 + $26 + $2.50 = $39
Conclusion
The manufacturing cost affects the selling price, frequently called the suggested retail price and profitability. By analyzing the manufacturing cost, business owners can optimize their production cost, improve their bottom line and offer better quality products at a lower price point. At AccelGrid, we offer scalable MRP software that helps you track, analyze and optimize your manufacturing cost effortlessly. Start a free trial today, or get in touch with us to learn more.
