What company doesn't want to cut expenses and increase profits? All of them! The thing is, to achieve these goals, the production manager needs to know how to calculate industrial cost. Not only that, they need to know how to allocate indirect costs and calculate man-hours.
Don't know what industrial cost is, or why controlling direct and indirect manufacturing costs is important? In today's post you will find everything you need for effective, error-free cost control.
Ready? Then let's go!
After all, what is industrial cost?
Industrial Cost, also known as Total Production Cost, is the sum of all expenditures and expenses incurred during the manufacture of products.
These expenditures and expenses can be categorized as direct costs (those tied to production) or indirect costs (those not directly tied to the production process).
Within direct and indirect manufacturing costs, there are costs that are fixed and variable. Fixed costs are the expenditures and expenses that remain constant regardless of production volume, while variable costs are those that change according to the quantity produced.
Since it is practically impossible to identify indirect costs per unit of item produced, the company needs to divide these expenditures and expenses proportionally. This division is known as allocation (rateio), and it serves to assign a fraction of the indirect costs to each product.
Man-hour calculation — computing employees' worked hours — also needs to be performed if the manager wants to measure the labor cost per item produced.
Overhead allocation and man-hour calculation: how to do it?
Since calculating cost allocation and man-hours is complex, we've prepared two examples below to make the explanation easier. Check them out!
Allocating indirect costs
Let's say your company spent R$150,000 in indirect costs and you want to allocate that amount across three products. You will use the amount spent on raw materials as the basis.
Producing part X cost R$50,000, part Y R$20,000, and part Z R$30,000. In other words, the total spent on raw materials came to R$100,000 (50,000+20,000+30,000).
Once you have the total raw material spend, it's time to find each product's share percentage. To do that, take each product's production value and divide it by the total raw material spend. In this case: Product X (50,000/100,000 = 50%); Product Y (20,000/100,000 = 20%); and Product Z (30,000/100,000 = 30%).
Once you have the percentage, you need to take that rate and multiply it by the total amount your company spent on indirect costs. So we have: Product X (50%*150,000 = R$75,000); Product Y (20%*150,000 = R$30,000); Product Z (30%*150,000 = R$45,000).
Man-hour calculation
Suppose 20 workers at your plant dedicate 10 workdays to complete an order of 1,000 units. Estimating that they work 8 hours a day, the total hours per person can be obtained as follows:
20 workers x 10 days worked x 8 hours a day = 1,600h
After doing this multiplication, take the number of units produced and divide it by the total hours worked. In this case:
1000/1600 = 0.625 units per hour.
Once you have the man-hour figure, in this case 0.625, it becomes easier to apply this cost to each of the products.
Problems when costs are not controlled
If the company has no control over direct and indirect manufacturing costs, fixed and variable costs, it will probably run into problems when calculating man-hours, allocating overhead, and computing the cost of the finished product.
Controlling costs allows the company to identify exactly how much was invested in manufacturing the items, and how much it needs to sell the products for in order to be profitable.
How controlling direct and indirect manufacturing costs helps the company
Controlling direct and indirect manufacturing costs, fixed and variable costs, is important for the company to arrive at a fair product price. However, that is not the only advantage.
This control also helps the manager gain a broader view of everything that has been invested in manufacturing. And that knowledge will be extremely valuable for making more assertive decisions to reduce production expenses and redirect investments.
The manager can also secure more profitability through cost control, since the selling price is formed accurately and losses are avoided. In addition, it is possible to improve product quality and optimize working time in operations.
How to control direct and indirect manufacturing costs
The best way to control direct and indirect manufacturing costs is to build a history of all the expenditures and expenses the company incurred while manufacturing a product.
Ideally, this history should be compiled monthly, to make managing the information easier, and preferably in a management software system.
By monitoring costs month by month, it becomes easier for the manager to identify which processes are the most expensive. And, from there, take measures to contain costs and increase profitability.
Technology that helps with cost control
Since controlling direct and indirect manufacturing costs involves a great deal of data, the production manager can get lost doing it manually. After all, it's a lot of information.
Quantity of items produced, amount spent on raw materials, labor payments, amounts paid for outsourced services, packaging costs, water and electricity expenses, rent, office supplies, machine depreciation, maintenance, equipment insurance, and so on. These are just a few of the many aspects that need to be tracked.
Until recently, the Excel spreadsheet was the only tool capable of helping management professionals with this control. And it did not offer the security, reliability, and agility that industries need.
The good news is that, since more modern technologies arrived on the market, it has become easier for professionals to control the company's costs. Which means spreadsheets can now be retired, and management can be done without errors.
Through technologies like the M2 System, it is possible to control and manage all the information in a few clicks. Not only that — you can handle all pricing, project budgeting, and even shipment management of goods in one place.
The M2 System has something new: the Industrial Cost module, which totals direct and indirect manufacturing costs.
If you're curious to get to know this module, click and request a demo right now. See in practice how the M2 System can optimize your company's management and simplify cost control.
Originally published in Portuguese at useall.com.br.