Manufacturing Costs - How to Calculate (and Reduce) Your Production Costs

Being able to calculate and understand the costs that exist across your manufacturing operations is critical to understanding your business’s overall financial health. After all, if you're unable to calculate how much it costs to make your product, it can be nearly impossible to pin down your business’s profitability.

Ultimately, if calculating business costs involves guesswork or abstract extrapolations, then decisions made to drive continuous improvement won't be nearly as effective as you want them to be.

In this post, we'll explain why being able to calculate and reduce production costs should become a top priority, as well as provide tips to enable you to make better-informed decisions across your operations.

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Before you're able to dive into specific numbers, it’s essential to know which areas of the business impact your balance sheet. Some of these items directly influence production costs, whereas others do so indirectly.

Here are the costs that you need to keep account for in your manufacturing spend:

1. Materials costs

As earlier stipulated, some costs can be directly traced to the manufacturing process of a specific product.

For instance, if a business spends a given amount of funds on steel beams, these are direct material costs. In this case, the steel beams are physically manipulated to build the end product.

On the other hand, the total material costs can also include some particulars that you might not directly trace to the manufacturing process.

Take, for example, the rollout racks used in the storage of the steel. They can’t be directly tied into the finished product, but they are still a necessity. Therefore, they count towards the funds invested in the process, albeit indirectly.

2. Labor costs

As with materials, labor also, directly and indirectly, affects your balance sheet. Direct labor costs include the funds set aside to pay wages, as well as income taxes paid on behalf of production line workers, worker benefits, and contributions made into the workers’ retirement fund.

Employees that are included in labors costs include everyone from part-time workers to shop floor workers, engineers, quality managers, and all the way up to supervisors at director-level and C-suite responsible for driving business decisions.

3. Overhead costs

Manufacturing costs also include other elements that are not so apparent or directly attached to the production process. Consequently, these overhead costs inflate a business's total manufacturing cost. For example, your business needs a physical facility (or multiple), for which they pay rent.

Additionally, production facilities need equipment and utilities to operate smoothly. In addition to these costs, services like maintenance and even security should be factored in.

So, while they're not always directly considered part of the manufacturing process, these incurred costs also significantly can also impact your business's bottom line.

Although slightly complex, calculating manufacturing costs follows some basic mathematical principles. It requires you to sum up the cost of materials as well as labor. Furthermore, you need to work out the more convoluted overhead costs.

Basically, it comes down to this:

Manufacturing cost = [materials cost + labor costs + overhead]

And to find out the unit manufacturing cost—that is, the cost of producing a single product—you need to divide the total manufacturing cost by the number of units that have come off the production line.

Calculating each of the discrete entries above requires some more number crunching to ensure that you’re working with accurate and representative figures.

Additionally, it’s prudent to calculate manufacturing costs with a production timeline in mind. This way, it becomes easier and more manageable to pinpoint the number of funds being allocated to the manufacturing process in that time frame.

Reducing manufacturing costs plays a central role in moving your books further into the black.

However, cutting back on these costs is usually associated with a decrease in production quality. But it doesn’t need to be so.

In fact, several cost-cutting mechanisms streamline the manufacturing process, leading to higher quality products and healthier books of accounts.

Here are a few effective methods to reduce manufacturing costs without hurting the process and the product:

Cut down on the material costs

Materials are one area where businesses can spend a significant amount of money. To reduce the impact of these costs on your operation, look for less costly raw materials. While sourcing cheaper materials can help drive down total costs, it's important to ensure that the quality and integrity of your products do not suffer as a result.

Consider changing suppliers

If sourcing cheaper raw materials ultimately impacts the quality of the products coming off the line, consider looking for deals and arrangements with other suppliers.

In some instances, it can be possible to negotiate with the current suppliers to cut back on their asking price. For example, the promise of a more extended contract with them can entice them into providing materials at a lesser cost.

Make use of waste and leftover material

Rather than discarding leftover material, it’s prudent to feed it back into the production line, ensuring that you draw more value from it.

Alternatively, you can sell the waste off to other parties that have a use for it. Consequently, the business recoups some of the money put into acquiring the materials.

Try the automation route

As earlier explained, labor costs can drive up the total manufacturing costs significantly. As such, it makes business sense to cut back on this area to make for a leaner operation.

Therefore, tooling your manufacturing plant with more automated machines pays off in the long run. After all, the devices are most likely more efficient than human input, making the production move even faster.

Save on energy consumption

Cutting back on energy consumption by going green can significantly bring down your overhead. According to Forbes, unsubsidized renewable is the cheapest source of energy for manufacturers. Therefore, switching to this energy form makes the operation less costly.

Alternatively, you can install edge devices that manage the current machine setup. These devices monitor the energy consumption on the factory floor, turning off machines that aren’t running and optimizing supply to those that need it.

We've written about reducing cost of quality ad nauseam in previous blog posts and webinars. Since the advent of Industry 4.0 (and subsequently, Quality 4.0), the market has been flooded with solutions designed to help manufacturers better track production, streamline quality management, and increase efficiency.

In the webinar below, we review in detail how these new technologies like Tulip are helping reduce the cost of quality for businesses across industries.

If you're interested in learning how Tulip can help reduce your manufacturing costs, reach out to a member of our team today!