How to Calculate the Cost of Manufacturing and Why It's So Important
Any manufacturing executive will tell you that if you don’t have adequate data on your manufacturing costs, there’s no way to know whether you will hit your revenue targets. If you don’t know how to calculate the cost of production, you also won’t know whether your production process is as efficient as it could be.
Without an accurate grasp of your profit margins, you won’t be able to make effective and informed business decisions for the future. And without unveiling hidden inefficiencies, you have no way of knowing how to drive down manufacturing costs and expand your profit margins.
Digital manufacturing solutions can help identify, measure, and control these costs. But it also requires business leaders to have a deep understanding of how to calculate the cost of manufacturing. That understanding can take a career to hone, but we can introduce the basics of how to identify and calculate estimated manufacturing costs.
Identifying manufacturing costs
To accurately determine the cost of manufacturing, you must have a reliable handle on the elements of your total manufacturing costs. There are direct and indirect costs, so it is important to recognize and fully account for these. To understand these, we’ll use the example of a discrete manufacturer.
- Materials costs. This is the cost of all of the raw materials used to create your finished product. These can be direct, such as prefabricated pipes that will be used to fabricate finished equipment. These can also be indirect, such as the palettes and bands used to safely store the pipes.
- Labor costs. These costs can be direct, such as the salaries of those workers who are on the production line. But they can also be indirect, such as the costs of those who deliver raw goods to your factory.
- Manufacturing overhead. This is the broader category of costs that are neither direct materials or workers, and is more difficult to accurately project. It can include utility costs, tariffs, leased properties and equipment, as well as service costs.
How to calculate the cost of manufacturing accurately
Once you have defined all these costs within your manufacturing line, you’ll be able to accurately determine just how much it costs to produce one of your products. In practice, the math is more complicated, but in principal, the equation is as follows:
Manufacturing Cost = (Raw materials + Labor cost + Allocated manufacturing overhead)/number of units
The raw materials for one widget may be $42.50. The direct labor costs may equate to $10 per widget, with many chairs produced per hour. As mentioned, accounting for overhead can be difficult, but is vital to an accurate calculate. These costs may include rental space, janitors, electricity and internet bills.
These costs are divided by the amount of units produced for the span of time you are calculating costs for, whether that is hourly, daily, weekly, quarterly, or annually.
By having a full understanding of your manufacturing costs, you can predict your future margins. As you scale up (or scale down), you should bear in mind that some costs, like bulk purchases, will drive your cost per unit down. Similarly, investing in larger machines may increase your maintenance and electricity costs. By knowing past costs, it will become much easier to predict future revenue and build your business plan around that.
Digital manufacturing solutions can help calculate costs—and reduce them
Digital manufacturing combines of technology, information, and innovation. It involves of connecting your manufacturing assets to information collecting sensors and cloud computing systems. Its benefits are many, including the ability to more accurately account for costs, and to make operational improvements to reduce those costs.
Because equipment, machinery, and assets are sensored, you can get a much accurate understanding of power usage, uptime, and both planned and unplanned downtime. Because of the depth of data being collected, you can get a more granular view into inefficiencies—making them easier to address. So instead of simply calculating the projected cost of service for a failure-prone pump in your factory, and IIoT-enabled smart manufacturing implementation may reveal that using the pump above 80% capacity during peak hours will lead to eventual failure on a quarterly basis, but that running the pump above 73% capacity will prevent the problem.
Manufacturing costs are your principal limitation on revenue, profit and overall growth. In turn, controlling those costs are limited by your ability to recognize, measure, and control those costs. Digital manufacturing solutions can improve all three of those abilities.
Learn more about how our Digital Manufacturing solutions can benefit your operations, and check out our eBook, Smart Manufacturing - the Journey to Success.