Knowing your manufacturing costs lies at the very heart of making heads and tails of your business’s financial health. After all, if you don’t know how much you spend to make your product, it becomes harder to pin down your business’s profitability.
And if pinning down that profit figure involves guesswork and abstract extrapolations, then subsequent business decisions might not be as effective as you want them to be.
After all, if you don’t know what it takes to run the production line, you won’t be able to streamline the manufacturing process to increase your profit margin.
As such, we believe this guide to calculating and reducing production costs should come in handy if you seek to make informed decisions to further your business.
Identifying your manufacturing costs
Logically, before you can crunch the all-important numbers, it’s essential to know the exact manufacturing areas that significantly impact your balance sheet. Some of these items directly impact 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 fabrication operation spends a given amount of funds on steel beams, these are direct material costs. After all, the steel beams are physically manipulated to come up with the final 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. The direct labor costs entail the funds set aside to pay wages. Additionally, this category of labor costs also comprises pay-as-you-earn tax paid on behalf of production line workers, worker benefits, and contributions made into the workers’ retirement fund.
Contrastingly, some labor costs aren’t directly traceable to the workers operating on the production line. For instance, the business spends money on individuals who deliver raw materials to the factory.
Not only that, managers and supervisors aren’t often physically involved in the manufacturing process. However, they are also on the payroll and count toward labor costs.
3. Overhead costs
Manufacturing involves other factors that aren’t so apparent or directly attached to the production process. Consequently, the costs incurred through these factors, known as manufacturing overhead, inflate the total manufacturing cost. For example, your operation needs a manufacturing plant for which you pay rent.
Additionally, production needs equipment and utilities to operate smoothly. To these costs, add services like factory security.
So, while not necessarily part of the manufacturing process, these incurred costs also significantly affect your business’ finances.
How to calculate manufacturing costs
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.
Five effective ways to reduce manufacturing costs
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 spend hefty sums. To reduce the impact of this on your operation, look for less costly raw materials. However, ensure that this move doesn’t affect the quality and integrity of your products.
Consider changing suppliers
If swapping out the current raw materials for cheaper ones impacts the quality of the products coming off the line, consider deals and arrangements by other suppliers.
In other 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.