How to Calculate Total Manufacturing Cost: Practical Steps and Tips

Table of Contents

• How to calculate total manufacturing cost: Three core components
• Calculating total manufacturing costs step-by-step
• Common mistakes made when calculating TMC
• TMC vs related metrics: COGM, COGS, and more
• Practical tools and templates to utilize
• Final thoughts: Key takeaways to consider

How to calculate total manufacturing cost: Three core components

Direct materials cost

• These are the raw materials and components that eventually become part of the finished product. Their usage can be traced directly. For example, circuit boards, metal casing, and chips in an electronics plant.
• To track usage and waste, use inventory records, bills of material (BOMs), and production logs. You should always account for material that’s spoiled, scrapped, or lost.
• To get the direct material cost to use in the TMC formula:
  • Direct materials used = Beginning raw materials inventory + purchases of raw materials – Ending raw materials inventory

Direct labor costs

• Wages, overtime, salaries, payroll taxes, and benefits tied to workers who physically work on the production line all count as direct labor. Janitorial staff and supervisors aren’t included.
• Multiply the hours worked by an all-in labor rate (including payroll taxes and benefits).
• If the time of the worker can’t be directly traced to a product line, or they’re a supervisor or work in maintenance, this counts towards indirect cost. This should be allocated as an overhead and not under direct labor.

Manufacturing overhead (indirect cost)

• Overhead includes all indirect costs that are needed to support the manufacturing process. These can’t be traced to a single unit.
• Overhead such as factory rent and manufacturing equipment is fixed, whereas some are variable such as indirect supplies and power usage.
• Because you can’t change overhead directly for each product, you use an overhead rate/predetermined overhead rate instead. The overhead should be allocated across products based on some base (e.g. machine hours).
  • Predetermined overhead rate = Estimated total overhead ÷ Estimated total allocation base (e.g. total direct labor hours)
  • Applied overhead = Overhead rate x Actual usage of the base by that period/job
• If your allocation base isn’t chosen well, overhead may be underapplied or overapplied, leading to skewed unit costs.
• Examples include: Rent of factory/machinery, utilities, maintenance, indirect materials (e.g. cleaning supplies), insurance, and depreciation.

Calculating total manufacturing costs step-by-step

1. Use the basic formula: TMC = Direct materials + direct labor + manufacturing overhead
2. Gather data: Decide time period, pull beginning and end data raw material inventories, direct labor hours and rates, purchases, and overhead records. If data is missing, you may need to use estimations but this will impact your cost analysis.
3. Compute each component:
   a. Direct materials via inventory + purchases – ending raw materials
   b. Manufacturing overhead by applying the predetermined overhead rate to the base usage
   c. Direct labor via hours x rate (benefits included)
4. Add everything up to get the TMC for that period.
5. If needed, derive unit cost: Unit manufacturing cost = TMC ÷ Number of units produced

Common mistakes made when calculating TMC

1. Overhead allocation errors – Choosing a bad allocation base and failing to update the predetermined overhead rate on a regular basis can lead to future problems. Letting underapplied or overapplied overhead accumulate without making adjustments also needs to be avoided.
2. Misclassifying costs – Mixing up direct vs indirect costs, such as putting indirect materials as direct. Including period costs (marketing, selling, admin expenses) in manufacturing costs is also a common error to be aware of.
3. Data collection problems – Inaccurate/incomplete physical inventory counts and missing labor time records or rounding errors can cause data collection problems. Fluctuating raw material prices can distort the material usage figure as well.
4. Ignoring work-in-process (WIP) inventory effects – When calculating “manufactured” costs, ignoring partially finished goods may cause figures to be off.

TMC vs related metrics: COGM, COGS, and more

• Prime costs = Direct materials + direct labor
• Variable vs fixed manufacturing costs – Splitting overhead into variable and fixed parts can aid detailed analysis.
• Conversion costs = Direct labor + manufacturing overload
• Total cost vs average cost – Ensure you don’t confuse a period’s total and the per-unit averages.

Practical tools and templates to utilize

1. Using Google Sheets or Excel to build a spreadsheet that automatically computes each component based on your input numbers can really save you time. You can often find free templates across financial blogs or software sites.
2. Systems such as Sage, NetSuite, and QuickBooks often have manufacturing cost modules that are able to track labor, materials, and overhead. They can generally compute TMC, COGM, and COGS too. Job order costing software can allocate overhead per job. For companies who have mixed products or more complex overhead, activity-based costing (ABC) can sometimes yield more accurate overhead allocation than a blanket rate.
3. Once you’ve computed TMC and other metrics, it’s time to produce reports. These should include product line cost breakdown, department-level overhead burden, trend analysis, and a comparison of actual vs budgeted costs.

Final thoughts: Key takeaways to consider