How you set a price determines your profit margin. However, selecting an appropriate price is a challenging task. When you are unaware of how much you are spending, price-setting becomes even more challenging.
Knowing how much it costs your business to make a unit of a commodity helps you price them appropriately so that you can not only cover your costs but also make a potential profit. Thus, determining the value to set a fair price is as necessary as doing bookkeeping to preparing financial statements. However, raw materials cost is not the only element to consider when calculating the total manufacturing cost per unit. Direct labor and manufacturing overheads are also equally important.
Total Manufacturing Cost
To determine the per unit cost of a product, you first have to calculate the total manufacturing cost of all the items manufactured during the given period. Then, divide the estimated value by the number of items. The end figure you obtain is one unit’s manufacturing cost. Understanding and calculating the total manufacturing cost is necessary as you can compare it to the total revenue generated and use it to determine your company’s profitability. This is especially crucial for small businesses lacking the privilege of a financial safety net. The most basic formula for determining total manufacturing costs is to add up all costs of direct materials, direct labor, and manufacturing overhead consumed during a given period, as follows:
Calculating the total cost of all materials directly utilized for manufacturing purposes
Direct materials are all the raw materials and elements that go into the finished product. If your company manufactures wooden furniture, expenses would include the wood in the furniture and the glues, nuts, bolts, and screws needed to hold the entire piece of furniture together. It would also have varnish or paint that goes into making the finished product. Consequently, all these expenses are simply the total cost of direct materials consumed.
Calculating the total cost of labor contributed to the manufacturing process
This has to include the basic salaries and wages of all the workers primarily employed in the manufacturing department and any incentives and benefits they receive.
Calculating the total cost of manufacturing overhead
Indeed, this is, by far, not only the final but also the most time-consuming step of determining the full value of manufacturing. To account for all sources and components of manufacturing overhead, you must consider every aspect of the following expenses incurred:
- Indirect Labor: This part includes the wages, salaries, benefits, and incentives of any employees who were not directly involved in the manufacturing process, but their labor was nevertheless crucial to the manufacturing process. They can, for instance, include supervisors, in-house quality inspectors, and janitors.
- Indirect Materials: Any of the materials consumed to maintain and repair the manufacturing equipment, tools, or building fall into this category. For instance, fuel used during manufacturing is part of the indirect material.
- Utilities: Any utilities that mainly keep the entire manufacturing facility operational are simply part of the manufacturing overhead costs. Such costs typically include water, sewage, electricity, telephone, and internet services.
- Repair and Maintenance: Any money spent on repairing and maintaining the machinery and building itself falls under the total manufacturing overheads.
- Taxes and Insurance: Any of the tax and insurance expenses you bear on the machinery and property used for manufacturing becomes part of manufacturing overheads.
- Depreciation: The loss of value of assets due to their obsolescence or usage is depreciation. This also has to be considered for manufacturing overheads.
- Stolen Assets: The money lost through stolen assets must be accounted for manufacturing overhead.
Adding up all of these costs accounts for the total manufacturing overhead.
Calculating Manufacturing Cost Per Unit
To determine the total manufacturing cost per unit, you must divide your total manifesting costs by the total number of units produced during a given period. For instance, if your business made 2 million units in 2017 and incurred total production costs of $10 million in the said year, the total manufacturing cost per unit is $5.
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