What are Total Manufacturing Costs?

Your total manufacturing costs are essentially an expense analysis that calculates how each of your company’s departments contributed to producing a finalized product. This looks at all stages of the manufacturing process from raw materials to work-in-progress to final result.

Total manufacturing costs showcase how much your company spent to produce its inventory in a given period of time. This includes a thorough account of the cost of overhead, materials used, labor, and any other manufacturing expenses that contributed to completing the product. This is not to be confused with the cost of goods manufactured (COGM), which refers to just the cost of inventory that was finished and prepared for the sale in the period. Rather, total manufacturing costs include all related costs accrued in the period.

Knowing how to calculate total manufacturing costs is incredibly important supply chain data. If you know your inventory value, you can calculate your company’s sales margins and use that information to identify where you could trim unnecessary expenses. You can also more accurately account for your inventory on your balance sheet and the cost of goods sold on your income statement, as well as compare your total manufacturing costs to your total revenue to quickly see profitability.

Some manufacturing companies may shy away from performing this analysis because it seems intimidating and time-consuming, but there’s actually a pretty straightforward total manufacturing cost formula developed by experts that you can follow — one you don’t need to be an accountant to use.

To get started, there are three things to consider for your calculation: direct materials, direct labor and manufacturing overhead.

What are Direct Materials?

Direct materials are all the materials you bought and used to make your final product, incurring material costs. This includes raw materials, components and any parts directly used in production. To calculate your total direct materials costs, you have to figure out how much of these direct materials you have, add the total cost of new direct materials, then subtract ending inventory at the end of the financial period.

Notice that it’s direct materials. Not all of your materials go into your products. Some go into scrap or other areas that aren’t the literal product. We’re focused on direct materials only, such as the rubber used to produce a tire or the fabrics that make clothes. We’re not talking about the cleaners you use to maintain the equipment that manufactures the product.

Steps to Calculate Direct Material Costs

• Begin with the raw materials inventory at the start of the period.
• Add the cost of new raw materials purchased.
• Subtract the ending raw materials inventory to find the cost of materials actually used in production.

Formula: Direct Materials = Beginning Raw Materials Inventory + Raw Materials Purchased – Ending Raw Materials Inventory

Example Calculation:

• Beginning Inventory: $50,000
• Raw Materials Purchased: $120,000
• Ending Inventory: $30,000
• Direct Materials Cost = $50,000 + $120,000 – $30,000 = $140,000

What is Direct Labor?

There’s no formula needed to calculate direct labor. Direct labor is simply the costs associated with paying people to create the product. Again, we’re focused on those directly involved in product production, such as employees who work on the assembly line, quality inspectors and the managers who oversee them. We’re not talking about HR (they’ll be accounted for below).

To calculate direct labor costs, add up what you pay in salaries, benefits, retirement funds, holiday pay, payroll taxes, workers compensation insurance, etc. for both your fixed-labor and variable-labor employees.

Steps to Calculate Direct Labor Cost

• Identify all wages and benefits paid to production workers.
• Exclude salaries of administrative staff or sales teams, as they are not part of the direct labor cost.

Example Calculation:

• Factory Worker Wages: $75,000
• Overtime Pay: $5,000
• Direct Labor Cost = $75,000 + $5,000 = $80,000

What is Manufacturing Overhead?

Finally, you need to know how to calculate total manufacturing overhead. This is everything else you need to keep your production running, which is a bit more indirect. Overhead expenses can really impact your balance sheet and income statement, so you need to track these costs. Knowing your firm overhead means you can budget the money needed to cover these costs.

Examples of firm overhead:

• The cost of keeping your equipment running (maintenance, water, electricity, etc.)
• Equipment depreciation
• Quality inspections of products
• Taxes and depreciation on your facilities

We’re not talking about costs to keep your company running, such as marketing or accounting. To get your total manufacturing overhead, add up the costs associated with actual production.

Steps to Calculate Manufacturing Overhead

• Sum up all indirect costs associated with production, including factory utilities, depreciation, and maintenance.
• Use an allocation method if necessary to distribute overhead costs accurately.

Example Calculation:

• Factory Rent: $25,000
• Utilities: $10,000
• Equipment Depreciation: $15,000
• Maintenance: $10,000
• Manufacturing Overhead = $25,000 + $10,000 + $15,000 + $10,000 = $60,000

Difference Between Total Manufacturing Cost, Cost of Goods Manufactured (COGM), and Cost of Goods Sold (COGS)

Understanding the distinctions between these key cost metrics is essential for financial planning and decision-making:

1. Total Manufacturing Cost (TMC)
   • Represents the total expenses incurred in producing goods within a given period.
   • Includes direct materials, direct labor, and manufacturing overhead.
   • It does not account for beginning or ending inventory of work-in-progress (WIP) products.
2. Cost of Goods Manufactured (COGM)
   • Represents the total cost of completed goods during a specific period.
   • It includes Total Manufacturing Cost plus the beginning inventory of work-in-progress (WIP), minus the ending inventory of WIP.

Formula: COGM = Total Manufacturing Cost + Beginning WIP Inventory – Ending WIP Inventory

1. Cost of Goods Sold (COGS)
   • Represents the total cost of goods that were sold during a specific period.
   • It includes COGM plus the beginning inventory of finished goods, minus the ending inventory of finished goods.

Formula: COGS = COGM + Beginning Finished Goods Inventory – Ending Finished Goods Inventory

How Do You Use the Total Manufacturing Cost Formula?

Now that you’ve calculated your costs associated with direct materials, direct labor, and manufacturing overhead, you have everything you need to add up your total manufacturing costs.

To calculate total manufacturing costs, plug your variables into this total manufacturing cost formula:

Direct Materials + Direct Labor + Manufacturing Overhead = Total Manufacturing Costs

Be sure not to underestimate any of your expenses for those three categories. Small details that may only amount to small expenses can still collectively make a big impact on your business. When adding, ensure total manufacturing costs really does mean total.

Why is it Important to Calculate Total Manufacturing Costs for Supply Chain Efficiency?

In manufacturing, your profit directly depends on your efficiency. By calculating your total manufacturing costs, you can subtract that figure from your total revenue to see the relationship between manufacturing, profit, and sales to understand how your spending is affecting your bottom line. Having this accurate, real-time view of your manufacturing operations expenses allows you to improve efficiency.

For example, you may identify that you could trim direct materials costs by substituting a high-cost material or supplier for a more affordable one that does the job just as well. Maybe you could reduce shipping costs by making more bulk purchases or buying more locally. You may see that your direct materials costs are driven up because you’re producing too much inventory in advance or more than you can sell in a period. Better forecasting can drastically cut costs.

Once you know your total manufacturing costs, you can ask yourself a few important questions, such as:

• Are there any costs that are way higher than I expected? Are any significantly lower? What contributed to that?
• Is my selling price yielding my profit goal?
• How much inventory do I have at the end of the financial period, and how much do I spend to hold onto it?
• Where can I improve processes or purchasing to wisely cut costs or time?

How Can an ERP System Help Organizations Manage their Total Manufacturing Costs?

When you’re running a complicated manufacturing operation with many moving parts, again, efficiency is key. That’s where it’s valuable to enlist the capability of an ERP system that can help you manage your total manufacturing costs. An Enterprise Resource Planning system is software that can help you manage all of the core supply chain, manufacturing, services, financial and other processes related to your organization. It can be used to help you simplify, plan, budget, automate and accurately report on your operations. Put simply, ERP software allows you to reduce the use of unnecessary resources without sacrificing quality.

Modern manufacturing ERP systems are designed to flexibly support and integrate into any manufacturing business process, creating a complete business management platform for your company. There are many benefits for manufacturing companies that use ERP systems, including:

• Better supply chain, warehouse, transportation and inventory management
• Improving communication between departments and comparing metrics across them
• Capturing real-time reporting you can quickly access
• Centralizing operational and financial information
• Optimizing operations for better efficiency, productivity and customer service
• Having the ability to adapt when faced with business changes or disruptions

How Can Digital Manufacturing Improve Total Manufacturing Cost Management?

You’d be hard pressed to find a streamlined, efficient manufacturing company today that isn’t utilizing digital manufacturing technology. Software solutions like Manufacturing Resource Planning (MRP) technology or Quality Management Systems (QMS) can completely reshape a company’s total manufacturing costs for the better.

QAD’s solutions help global manufacturers increase profitability, improve productivity, provide better customer service, and manage their key manufacturing business processes for scalable growth opportunities. Our solutions are designed and implemented with manufacturing industry best practices in mind, such as:

• Lean manufacturing and process optimization
• Initiating preventive maintenance activities with Total Productive Maintenance (TPM) utilizing capacity planning and preventive activity
• Enabling automation with IoT and a connected technology stack
• Implementing an Enterprise Quality Management System and vertically integrating quality from planning through operations
• Collaborative organizational behavior including the elimination of paper on the shop floor
• Tracking trade compliance and environmental standards

These solutions provide visibility and execution, and with visibility comes the ability to make more strategic business decisions. To streamline your manufacturing operations and gain the insight to reduce your total manufacturing costs, learn more about our solutions and how we can partner with you to improve your business.

FAQs

1. How do total manufacturing costs impact profitability?

Total manufacturing costs directly affect a company’s profitability by determining the cost structure of production. If total manufacturing costs are too high, profit margins shrink, making it harder to compete in the market. By optimizing these costs—through lean manufacturing, automation, and supplier negotiations—companies can increase their gross profit margin. Understanding total manufacturing costs also helps set competitive pricing while ensuring a healthy profit.

2. What are some common mistakes when calculating total manufacturing costs?

Some common mistakes include:

• Omitting indirect costs: Many companies forget to include indirect costs like factory utilities or equipment depreciation.
• Incorrectly categorizing expenses: Misclassifying administrative costs as manufacturing overhead can skew the total cost calculation.
• Failing to account for waste and spoilage: Not tracking raw material waste leads to underestimating total material costs.
• Using outdated cost data: Prices of raw materials and labor fluctuate, so failing to update costs can lead to inaccurate calculations.
• Ignoring seasonal variations: Manufacturing costs may fluctuate due to demand shifts, making it crucial to track costs over time.

3. How do total manufacturing costs differ for small vs. large manufacturers?

• Small manufacturers: Typically face higher per-unit costs due to smaller production volumes, limited bargaining power with suppliers, and less automation. They also have higher variability in costs due to lower economies of scale.
• Large manufacturers: Benefit from bulk purchasing discounts, automated production processes, and more efficient cost structures due to economies of scale. However, they may have higher fixed costs, requiring high output to maintain profitability.

4. How can lean manufacturing principles reduce total manufacturing costs?

Lean manufacturing focuses on eliminating waste and improving efficiency in production. Key strategies include:

• Reducing excess inventory: Minimizing raw material and finished goods inventory to lower storage costs.
• Optimizing workflow: Streamlining production processes to reduce idle time and bottlenecks.
• Improving quality control: Preventing defects and rework reduces waste and labor costs.
• Standardizing procedures: Implementing best practices to cut down on inefficiencies and human errors.

5. What role does automation play in controlling total manufacturing costs?

Automation helps manufacturers reduce costs by:

• Lowering labor expenses: Automated systems can handle repetitive tasks with minimal human intervention.
• Increasing production efficiency: Machines operate faster and with greater precision, reducing defects and material waste.
• Enhancing energy efficiency: Smart manufacturing systems optimize power usage, cutting down on utility costs.
• Minimizing downtime: Predictive maintenance through automation prevents unexpected breakdowns and costly repairs.

6. How do fluctuations in raw material prices affect total manufacturing costs?

Raw material price changes have a direct impact on total manufacturing costs. If raw material costs rise, total costs increase, leading to either reduced profit margins or higher product prices. To mitigate price fluctuations, companies can:

• Negotiate long-term contracts with suppliers for stable pricing.
• Source from multiple suppliers to avoid dependency on a single vendor.
• Use alternative materials that are cost-effective without sacrificing quality.
• Monitor market trends to anticipate and adjust pricing strategies accordingly.

7. What is the relationship between total manufacturing cost and break-even analysis?

Break-even analysis determines the point at which total revenue equals total costs, meaning there is neither profit nor loss. Total manufacturing cost plays a crucial role in this calculation:

• Break-even point formula:
  
• If total manufacturing costs are high, a company must sell more units at a higher price to break even.
• Reducing total manufacturing costs (through efficient production, material savings, or automation) lowers the break-even point, making profitability easier to achieve.