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Manufacturing Overhead: How to Calculate Labor Cost by Job

Manufacturing Overhead Costs

Manufacturing Costs include Direct and Indirect Labor Cost
To calculate Manufacturing Overhead by Job, be sure to include both manufacturing direct labor costs and manufacturing overhead labor costs.

How To Calculate Labor Cost

One key in calculating the labor cost portion of your manufacturing overhead is understanding the difference between manufacturing direct labor costs and manufacturing overhead labor.

Which of these should you include in your costing and pricing models?

Manufacturing Direct Labor Costs

Manufacturing direct labor costs include expenses associated with employees who are directly involved in the production of goods. These costs include wages, benefits, and any other compensation paid to workers who transform raw materials into finished products.

Manufacturing Overhead Labor Costs

Manufacturing overhead labor costs are for people who support manufacturing processes but don’t directly contribute to physically creating the product. This can include personnel like maintenance workers, quality control staff, or factory supervisors.

These roles are necessary for the smooth operation of the production process. However, they don’t directly participate in the actual transformation of raw materials into finished goods. Therefore their wages and benefits are considered part of manufacturing overhead costs rather than direct labor costs.

Calculating Your Manufacturing Costs

Are you looking to put together an accurate manufacturing cost number? If so, you’ll want to include the cost of your direct labor plus the ‘burden’ accompanying that direct labor. And don’t forget to include related ‘manufacturing overhead’ labor costs.

Calculating Overhead Labor Costs by Employee

In addition to direct labor employees, there are normally 2 types of overhead employees in your labor force:

  1. 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 is typically very difficult to establish.
  2. Overhead employees are needed and become part of manfuacturing costsPeople who directly support the production process. For example:
    • Engineering or Design
    • Supervisors and schedulers
    • Purchasing
    • Warehousing
    • Quality Control
    • Shipping
    • Delivery
    • Equipment repair and maintenance
    • Others…

You should include the costs from Item 2 in your managerial and estimating calculations. They are an integral, supportive segment of the production process; think of them as indirect costs of production.

Labor-Burden Analysis

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 (a fairly extensive list!)
  • Special equipment or vehicle requirements
  • Facilities cost
  • Costs flowing through from ‘manufacturing overhead’ types of workers

Compute fully burdened cost for both direct and indirect employeesFor 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 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 costs 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 Labor Costs 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, it means that 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.

Understanding Manufacturing Overhead

Don’t leave your employee’s per-production hour cost to industry averages, outdated analyses, or (what are often 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.

“Fully-Burdened Labor Cost”
I.e., what it costs an employer for an employee to produce work for a specific period of time…

(…usually shown as a “per-hour” rate.) 

Labor Burden is an essential element of Job Costs

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