How often did you work on a large-scale order, and once you dispatched the last package, it turned out there was no profit made, not to mention the anticipated earlier bonus? Alternatively, you might be under the impression that even though your workers do overtime and try their best – the production doesn’t progress as fast as it should, so you don’t make sufficient profit.
Why is that? Maybe a naughty pixie tries to mess up your cost calculation? The explanation is more direct – indirect costs. They are rarely considered daily, and it’s easy to forget about little expenses for things like cleaning and security. This is why calculating manufacturing overhead can help to resolve this issue and bring to light all the costs you might have lost track of.
What is Manufacturing Overhead?
Manufacturing overhead is all indirect costs incurred during the production process. This overhead is applied to the units produced within a reporting period.
When you think of what costs you have outside of direct materials, labour and manufacturing processes, you might be overwhelmed by the thoughts that cross your mind. But are there so many details that cost your business money? First, of course, we are talking here only about indirect costs linked to manufacturing (so forget marketing, sales, or administration).
Examples of expenses that are included in the manufacturing overhead category are as follows:
- Depreciation on equipment used in the production process (your equipment doesn’t last forever, and it’s always costing you something even if you don’t know it), so depreciation basically refers to how much an asset decreases in value over time.
- Salaries of your staff. You might think it obvious but remember to include quality control, technologists, cleaners, maintenance, security guards, etc.
- Supplies not directly associated with products are known as indirect materials (such as manufacturing forms). These are all extra bits and pieces that go into making your product, which wouldn’t stand out on first look. This could also repair parts, general supplies, cleaning chemicals and even wasted materials, and computer systems such as MRP management software.
- Utilities. Rent on the building, water bills, internet, electricity, gas, property tax and even insurance, as long as they are related to manufacturing.
Calculating manufacturing overhead
To calculate manufacturing overhead, you must add all the indirect company-related expenses incurred in manufacturing a product (indirect materials, indirect labour, machine repairs, depreciation, factory supplies, insurance, electricity and more).
You have to be aware of these invisible costs of production that build in the background. Otherwise, you’ll be checking your end-of-year balance and find it looking slimmer than you expected.
That forgotten machine set up, hours spent on technical drawing, and a few cheeky breaks for a ciggie your workers are happy to take every day – they all add up.
And these hidden costs will keep on building up on your statement unless you take the time to reduce the unnecessary ones and take back control.
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Calculating production in practice – how to calculate manufacturing overhead
Usually, manufacturing overheads are calculated per product annually.
If you’re a small business, it will be helpful to do it even more often than that. The effects of your overheads could be pretty drastic throughout the year, and you wouldn’t know until you checked.
Let’s take a look at some fantasy numbers. Imagine making pretty unique coffee tables, so the demand is constantly growing. What are your invisible costs?
- Indirect labour.
Somebody has to clean all the dust, as sawing can be messy. You don’t want the woodchips and bits to get everywhere, so you have a deal with a cleaning company – they came to sort things out and send a monthly invoice. Let’s assume that it comes to 1800$ per year.
- Indirect materials and depreciation
It’s good to remember that your equipment doesn’t last forever, and it’s always costing you something even if you don’t count it. So how much does it cost? Let’s round it to 400$ per year for materials. What about depreciation? If a particular saw is estimated to cost 2100 $ and it lasts seven years, the potential annual depreciation is:
2100 $ / 7 = 300 $
Right, these numbers are a bit far-fetched, but we only want to show you what kind of invisible costs are hidden in your business.
Unfortunately, you can’t make hundreds of tables in your living room. You got to pay rent for your workshop, bills, gas, water, electricity, etc. How much? Between 9000-15000$ a year for a small/medium-sized workshop. Let’s agree on 10000$ annual costs.
Now that we have all the numbers worked out, we can add them and get our total indirect costs.
1800 + 400+ 300 + 10000 = 12500 $ per year
How many tables a year do you make? Let’s say that 600 tables.
So what is the total manufacturing overhead?
Total indirect costs / Number of items produced = 12500/ 600= 20.83 $
That is the manufacturing overhead per single item.
How to reduce manufacturing overhead?
Well, of course, the aim is to run the cost down, so every little difference we make here will contribute to the total savings.
Here are some ideas on how can you hammer those costs down:
- Set budgets – once you get your indirect costs worked out, start setting targets for getting them down. If you review these every few months, by the end of the year, you will be surprised at the difference you have made;
- Reduce waste – if your materials get broken or damaged, they result in indirect materials costs. Try to see where the most significant waste is coming from and tackle your production planning strategy head-on;
- Save where you can – use energy-saving light bulbs and encourage everyone to be frugal with their water usage. Every drop counts, and mother nature will be pleased too;
- Talk to your staff – the best people to help reduce indirect costs are the people that spend the most time in your workshop. More than likely, they’ll have some unique ideas for tweaks here and there;
- Shop around – compare various offers to find the best suppliers to cut down on energy, gas, etc., bills. You might well be paying more than you should for your utilities, especially if you are taking them all from one place;
- Save on software – implementing ERP systems can be overkill in terms of features and cost. It is not worth overpaying for sophisticated software you don’t need. That’s why maker-focussed systems like Prodio management software are much more appropriate for small manufacturers.
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How can Prodio software be the right tool to reduce your manufacturing overhead?
Implementing the right software is usually a good starting point for reducing manufacturing overhead – it’s too easy to overspend on a system beyond your needs and come back to square one using pen and paper or Excel spreadsheets. On the other hand, the big bucks ERP system is usually too complex for a small manufacturing company.
Keeping an eye on manufacturing overhead is a clever thing, not only from the accounting perspective. As the owner of a manufacturing company, you should have full shop floor control. Of course, it’s not going to be a core piece of information for your running of the business, but the effects on your profit margins will be there. But by breaking it down, you get to see how you can increase your profit margins through some straightforward changes. In addition, prodio manufacturing software has been designed with the maker’s needs in mind, so you won’t be paying for features you’ll never use.
You can benefit from:
- Work history – fast sums accordingly to personalised filters to help you calculate your production
This bookmark is an easily accessible vault of information regarding the working history of the whole company. Every clock in and clock out is saved together with the information about the quantity and number of shortages, raw material consumption, or deficiencies. In the background, Prodio measures the efficiency. If there was a norm set for a particular product, it also shows how many per cent of this norm an individual employee achieved.
By using clever filters, you can find any required operation in work history, giving you almost unlimited summing possibilities.
Total order calculation – check quickly how long it took to complete your order and whether there were any discrepancies between the estimated time and lead time. It should be one of your favourite functions from the manufacturing overhead perspective.
There you will find:
- Total number of working hours your employees spent at production divided by particular operations,
- Total number of working hours for all operations for a given position on the order form,
- Estimated times are based on the product’s technology, suggesting the lead time.
This simple table will show you whether the estimated time was sufficient and the whole production profitable for a particular order.
- Advanced reports
When it comes to advanced production cost tracking, each company does it differently, so creating a standardised report in Prodio would be impossible.
That’s why we prepared a complete Excel export tool, so you could source required data, as well as the whole working history and have it saved on your hard drive independently.
When you use for production accounting the number of pieces made rate, you will find here everything you need: employee name and surname, type of operation, number of parts produced, dates – just one cross tab, and you are ready to sign paychecks :). Crosstables are the best ways to get your reports, so we recommend them.
- Advanced productivity analyses
You can verify aggregated machine occupancy in particular weeks of the year (both for past and upcoming periods based on production schedule) and compare the productivity of your whole production and the productivity of a specific employee – the percentage of time spent on machine work (clock in and clock out times), the total sum of working hours and time paid at work daily, weekly and monthly.
- HR and payroll reports
Thanks to a simple build-in Time and Attendance Tracking module in Prodio, your accountant / external accounting firm will have much more manageable tasks. These features mentioned above mean more control over spending your money and resources because you’ll be saving on manufacturing overhead costs whilst tackling your direct costs simultaneously.
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