To calculate Manufacturing Overhead by Job, be sure to include these labor costs
Manufacturing direct labor costs vs. manufacturing overhead labor: what’s the difference? And which should you include in your costing and pricing models?
Direct production costs obviously include costs of inventory utilized, special-order materials, production facilities, high-dollar equipment usage, contracted services from outside vendors, and direct labor costs for payroll and payroll taxes.
But it can be easy to overlook labor costs that are often viewed as ‘company overhead’.
Are you looking to put together an accurate manufacturing cost number? If so, you’ll want to include not only the cost of your direct labor but the ‘burden’ that accompanies that direct labor. And don’t forget to include related ‘manufacturing overhead’ labor costs.
Calculating Both Direct and Overhead Labor Costs by Employee
In addition to direct labor employees, there are normally 2 types of overhead employees in your labor force:
- People who may be strictly administrative (examples include marketing, bookkeeping, or accounting staff, company owners, administrative assistants, receptionists, janitorial staff, etc.). The relationship between the costs for these employees and finished products are typically very difficult to establish.
… - People who directly support the production process (e.g., engineering or design, supervisors and schedulers, purchasing, warehousing, quality control, shipping, delivery, equipment repair and maintenance, and so on). The costs for these employees should be rolled into your managerial and estimating calculations as an integral, supportive segment of the production process – think of them as ‘indirect’ costs of production.
Using labor-burden analysis, you can determine exactly what each employee costs and then include both fully-burdened direct labor and fully-burdened indirect labor (‘production or manufacturing overhead’) costs into both your estimated and actual costs.
To Compute the Manufacturing Overhead Cost for Each Employee…
Owners need to consider:
- Whether the employee fits best into the direct labor, production support, or administrative category.
- The cost of regular and overtime payroll, payroll taxes, training, and benefits (this can be a fairly extensive list!)
- Special equipment or vehicle requirements
- Facilities cost
- Costs flowing through from ‘manufacturing overhead’ types of workers
For instance, a supervisor may ‘support’ a group of 5-10 other employees. If supervisors cannot assign their time to specific jobs, their fully burdened costs should flow through to the employees supervised.
In another example, a purchasing department may purchase the products needed by the production department, so those costs should either be assigned to specific jobs or flow through to the employees in the production department.
The idea is to ultimately assign or allocate all direct and indirect costs out to the cost of the finished product so that you can get a realistic picture of estimated product costs.
When you also apply burden costs to job-cost reports within your accounting system, you can compare estimated to the actual costs required to create your final product.
If you are creating inventory for sale at a later time, both direct costs and manufacturing overhead costs should be assigned to the inventory until it is sold. That way you will be matching income from a sale to the applicable cost.
How Else Can You Use Direct and Manufacturing Overhead Labor Costs?
An informed and realistic view of your fully-burdened labor costs will also help you determine whether you should:
- Authorize overtime and/or
- Hire and train new workers to take on excess workloads tasks and/or
- Outsource certain aspects of the manufacturing process – or bring various elements back in-house.
Without a detailed cost of labor analysis, you’ll be making these critical decisions based on gut instinct rather than on facts. And we all know that ‘guesstimates’ can be costly!
Where Does Manufacturing Overhead Fit Into Your Gross Profit Target?
The best way to proceed of course is to get a firm understanding of EVERY SINGLE element that rolls into your production cost – both direct and indirect production costs.
When you know what it really costs to create your product, then you can price to achieve your desired Gross Profit. Of course, your target Gross Profit should be set high enough to cover both your true (non-production) company overhead costs as well as your desired bottom line profit.
Summary
Don’t leave your employee’s per-production hour cost to industry averages, outdated analyses, or what are commonly referred to as ‘SWAGs’ (silly, wild-****’d guesses)!
When you know your total, fully-burdened labor rates (plus your other tangible production costs) you’ll be able to establish pricing based on reliable numbers and profitability targets.
That’s when you’ll be in a position to carefully and intelligently monitor and manage operations to achieve your bottom-line goals.