How you set a price actually determines your profit margin. However, setting an appropriate price is a challenging task. And, when you are not aware of how much you are spending, price-setting becomes even harder.
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 cost to set an effective price is as necessary as doing bookkeeping to preparing financial statements. However, cost of raw materials 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
In order to determine per unit cost of a product, you have to first calculate the total manufacturing cost of all the items manufactured during the given period. Then, divide the calculated value by the number of the 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 total revenue generated and you 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 simply to add up all costs of direct materials, direct labor and manufacturing overhead consumed during a given period, as follows:
1. Calculating the total cost of all materials directly utilized for manufacturing purposes
Direct materials are, typically, all the raw materials and elements that actually go into the finished product. If your company manufactures wooden furniture, this category of expense would include not only the wood that ends up in the furniture but also all the glues, nuts, bolts and screws needed to hold the entire piece of furniture together as well as any varnish or paint that also goes into making the finished product. Consequently, the sum total of all these expenses is simply the total cost of direct materials consumed.
2. Calculating the total cost of labor directly contributed to the manufacturing process
This has to include not merely the basic salaries and wages of all the workers primarily employed in the manufacturing department, but also any incentives and benefits they receive.
3. Calculating the total cost of manufacturing overhead
Certainly, this is by far not only the final but also the most time-consuming step of determining the total cost of manufacturing. In order to account for all sources and components of manufacturing overhead, you must take into consideration each and 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/or repair the manufacturing equipment, tools or building simply fall into this category. For instance, fuel utilized during the manufacturing process is part of the indirect material.
Utilities: Any of the utilities that mainly keep the entire manufacturing facility operational is simply part of the manufacturing overhead costs. Such costs typically include water, sewage, electricity, telephone and internet services.
Repair and Maintenance: Any of the money spent on the repair and/or maintenance of the machinery and/or the building itself fall under the total manufacturing overheads.
Taxes and Insurance: Any of the tax and insurance expenses you bear on the machinery and/or property used for the manufacturing process becomes part of manufacturing overheads.
Depreciation: The loss of value of assets due to their obsolesce or usage is depreciation. This also has to be considered for manufacturing overheads.
Stolen Assets: The money lost through any stolen assets almost have to be accounted for manufacturing overhead.
Adding up all of these costs account for total manufacturing overhead.
Calculating Manufacturing Cost per Unit
In order to determine the total manufacturing cost per unit, you simply need to 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, then the total manufacturing cost per unit of the year is $5.
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