Key takeaways
- The total manufacturing cost formula is: total manufacturing cost = direct material cost + direct labor cost + manufacturing overhead.
- The direct materials cost formula is: direct materials = (starting inventory + purchases – ending inventory).
- The direct labor cost formula is: direct labor cost = labor hours × wage rate.
- Manufacturing overhead (MOH) encompasses all indirect expenses, including utilities, rent, maintenance, and insurance.
- The proper use of these formulas enables manufacturers to identify areas of cost concentration and optimize their operations, particularly by improving efficiency or automating tasks.
- Tracking costs enables better budgeting, reduces waste, and supports performance comparison across production sites.
Manufacturing is a tricky business, especially when trying to calculate total manufacturing costs. The process itself introduces a myriad of variables, ranging from input and output to direct and indirect costs. As a result, it’s a good idea to know how to use the total manufacturing cost formula.
Today, we’ll break down the total manufacturing cost formula, show how it works step by step, and explain how to use it.
Total manufacturing cost formula at a glance
The total manufacturing cost formula itself is pretty simple. It looks like this:
Total Manufacturing Cost = Direct Materials Cost + Direct Labor + Manufacturing Overhead
You’re probably wondering what all those terms mean, and we’ll get to that. But before we break down the formula, it’s important to understand which costs count toward your total manufacturing cost and which ones don’t.
What total manufacturing cost includes
Total manufacturing cost includes all the direct and indirect costs required to manufacture your products.
Direct costs are expenses directly tied to the manufacturing process. This includes (but isn’t limited to) direct materials and direct labor.
Indirect costs are expenses that support manufacturing but aren’t directly connected to producing a specific product. This includes (but isn’t limited to) factory utilities, equipment depreciation, rent, and other manufacturing overhead.
It’s important to factor in both your direct and indirect manufacturing costs when calculating total manufacturing cost.
What total manufacturing cost does not include
Total manufacturing cost only includes expenses related to producing your products. Costs that aren’t directly tied to manufacturing are excluded from the calculation.
For example, marketing, administration, and other general business expenses aren’t part of total manufacturing cost. While these costs are still important for understanding your overall profitability, they aren’t included in the manufacturing cost formula.
How to calculate direct material cost
Direct material cost is the first component of the total manufacturing cost formula. It measures the cost of raw materials used in production.
Direct material cost formula
Businesses calculate direct material cost by adding the cost of material purchases to the value of beginning inventory and subtracting ending inventory to find the direct materials used during the period.
Direct Material Cost = Beginning Material Inventory + Material Purchases − Ending Material Inventory
Direct material example
For example, let’s say a company starts with 10 production kits, purchases 20 more, and ends with 5. The direct material cost is the value of 25 production kits. If each assembly kit contains $200 worth of raw materials, the total direct material cost would be $5,000.
Common direct material cost mistakes
The calculation itself isn’t necessarily complicated, but there are a lot of variables at play. And that’s before considering businesses that have multiple production cycles happening at the same time.
More production cycles mean more materials to track, making it easier for inventory records to fall out of sync. One of the best ways to avoid these issues is by using bill of materials software that keeps your BOM organized and current. It keeps all of your material requirements in one place and automatically tracks what’s used in production, so you don’t have to.
How to calculate direct labor cost
Direct labor cost is the second component of the total manufacturing cost formula. It refers to the wages or salaries paid to employees directly involved in the manufacturing process.
Direct labor cost formula
Businesses calculate direct labor cost by multiplying an employee’s hourly pay rate by the number of hours they spend working on production.
Direct Labor Cost = Hourly Pay Rate × Hours Worked
Direct labor example
For example, let’s say a manufacturing project requires 40 hours of work per week from an employee earning $25 per hour, and the project takes four weeks to complete.
$25 × 40 hours × 4 weeks = $4,000
In this case, the direct labor cost for the project is $4,000.
Common direct labor cost mistakes
Calculating direct labor cost may seem simpler than calculating direct material cost, but there are still plenty of variables to keep track of. Different employees may have different pay rates, and most manufacturing projects involve multiple workers rather than just one.
To keep your labor costs accurate, make sure you’re tracking the hours each employee spends on production and using the correct pay rates for every worker involved.
How to calculate manufacturing overhead
Manufacturing overhead is the final component of the total manufacturing cost formula and is often referred to as factory overhead. It refers to the indirect costs required to keep your manufacturing operation running, including indirect materials that support production but can’t be traced directly to a specific product.
Typical manufacturing overhead categories
Manufacturing overhead includes expenses such as:
- Factory rent
- Utilities
- Insurance
- Equipment maintenance
- Other indirect manufacturing costs
These costs are essential to the production process because they often include indirect labor, utilities, and maintenance that support every unit produced in your facility.
Manufacturing overhead example
For example, let’s say a business spends $400 per month on rent, $200 per month on utilities, and $150 per month on equipment maintenance.
$400 + $200 + $150 = $750
In this case, the total manufacturing overhead is $750 per month.
Common overhead allocation mistakes
One of the biggest challenges with manufacturing overhead is allocating indirect costs accurately. Unlike direct materials or direct labor, overhead expenses are shared across multiple products and production runs.
To improve accuracy, use a consistent overhead allocation method and make sure you’re including all relevant manufacturing overhead costs while excluding non-manufacturing expenses like sales and administrative costs.
How to calculate total manufacturing cost
Now that we’ve calculated our direct material cost, direct labor cost, and manufacturing overhead, we’re ready to plug those numbers into the total manufacturing cost formula.
Pulling from the numbers above, imagine you’re producing a single batch of 100 products. During that production run, you use $5,000 worth of raw materials, pay $4,000 in direct labor, and incur $750 in manufacturing overhead.
Using the formula:
Total Manufacturing Cost = Direct Materials + Direct Labor + Manufacturing Overhead
$5,000 + $4,000 + $750 = $9,750
In this example, the total manufacturing cost for the production run is $9,750. Dividing that amount by the 100 units produced gives you a production cost per unit of $97.50 per unit, which can help inform pricing, profitability, and production decisions.
Keep in mind that these values are completely made up for illustration purposes. Every business has different products, labor costs, and overhead expenses, so no two manufacturers will have the exact same total manufacturing cost.
It’s also worth remembering that real-world manufacturing costs are often more complex than our simplified examples. Additional expenses, such as overtime pay and certain manufacturing-related taxes or fees, may also need to be factored into your calculations.
If you like these formulas (or formulas in general), you’re going to love our Inventory Formula Cheat Sheet. We put together seven of the most commonly used inventory management formulas into one handy guide that’s free to download.
Total manufacturing cost vs COGM vs COGS
Three metrics you’ll often hear when calculating costs in manufacturing are: total manufacturing cost, cost of goods manufactured (COGM), and cost of goods sold (COGS). While they are all related, they measure different stages of the production process.
Total manufacturing cost measures what it costs to manufacture products during a specific period. It includes your direct materials, direct labor, and manufacturing overhead.
Cost of goods manufactured (COGM) builds on total manufacturing cost by accounting for work-in-progress (WIP) inventory. It represents the total cost of goods that were completed and moved into finished goods inventory during the period.
Cost of goods sold (COGS) goes one step further. It measures the cost of the products that were actually sold to customers. Since not every product you manufacture is sold immediately, COGS is usually different from both total manufacturing cost and COGM.
When to use the total manufacturing cost formula
Use the total manufacturing cost formula when you want to understand how much you’re spending to produce goods over a given period. It’s especially useful for:
- Measuring manufacturing efficiency
- Building production budgets
- Identifying opportunities to reduce material, labor, or overhead costs
- Calculating manufacturing cost per unit
Because it focuses only on production costs, total manufacturing cost is a valuable operational metric for manufacturers looking to improve profitability on the factory floor.
When to use COGM and COGS instead
Use COGM when you want to measure the value of products completed during an accounting period. It’s commonly used for production planning, inventory valuation, and preparing financial statements.
Use COGS when you want to measure the cost of products that were actually sold. Since COGS appears on your income statement, it’s the metric used to calculate gross profit and evaluate the profitability of your sales.
You can think of the three metrics as stages in the same journey:
- Total manufacturing cost: What it cost to manufacture products.
- COGM: What it cost to complete products.
- COGS: What it cost to sell products.
Each serves a different purpose, but together they provide a complete picture of your manufacturing costs, inventory, and profitability.
How to use the formula to reduce manufacturing costs
Calculating your total manufacturing cost is only the first step. The real value comes from using that information to identify inefficiencies and make better business decisions.
While there are many ways to reduce manufacturing costs, not all of them are sustainable. Downsizing, operating on razor-thin margins, or cutting corners in production can lower costs in the short term, but they often create bigger problems later.
Instead, the best approach is to improve the efficiency of your manufacturing process.
Reduce material waste and excess inventory
Your direct material costs can reveal whether or not you’re purchasing excess inventory.
For example, if you consistently end each production cycle with excess raw materials, that’s money tied up in inventory instead of being used elsewhere in the business. While some leftover inventory is expected, a recurring pattern may indicate that you’re overordering.
Monitoring your total manufacturing costs alongside your inventory levels can help you purchase more accurately, reduce waste, and free up working capital.
Improve labor efficiency without cutting quality
Reducing labor costs doesn’t have to mean reducing your workforce. Instead, look for opportunities to make your production process more efficient.
For example, you may find that one production line or facility is consistently overworked while another has available capacity. By tracking labor costs across different teams or locations, you can identify imbalances and make better staffing decisions without sacrificing product quality.
Control overhead with better visibility
Manufacturing overhead is often one of the hardest costs to control because it includes many indirect expenses. Tracking these costs over time makes it easier to spot trends and identify opportunities to improve efficiency.
For many manufacturers, that means investing in better processes or manufacturing automation. Automating repetitive tasks can reduce errors, improve productivity, and help keep overhead costs under control as your business grows.
Automate- with inFlow!
Something that business owners quickly learn is that businesses run on money. This isn’t hyperbole, either. In one way or another, every part of a business costs money. You need to pay employees, purchase (and maintain) inventory, and so on. If you’re running ad campaigns, even selling your inventory costs money!
Whatever time a business spends on a task has a monetary cost. It might be difficult to calculate– and it might be difficult to see– but it exists. It’s how automation saves businesses money.
Software systems can complete repetitive, menial, and time-consuming tasks in a fraction of the time it takes a human worker. This allows businesses to allocate their employees to other, more important areas. The result is a more efficient workflow that helps minimize direct labor cost. But how do you go about automating these tasks?
This is where inFlow steps in as part of a broader cost accounting system that connects inventory, production, and reporting. Instead of sinking time into managing spreadsheets, inFlow consolidates information in one place and provides updates in real-time. It has the ability to create a bill of material (BOM), as well as help calculate your cost of goods sold. And did we mention barcoding? Because there is no better way to automate manufacutirng then by ultilizing barcodes. Gone is the need to monitor stock levels and calculate potential output– inFlow does it all instead.
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