Calculating manufacturing overhead costs
As a business owner, you’re likely always looking for ways to reduce costs and improve your bottom line. One area that many ecommerce businesses need to pay more attention to when trying to accomplish this, however, is manufacturing overhead costs.
First, we’ll give you a basic understanding of manufacturing overhead costs. Then we’ll discuss how to calculate them with some examples to help illustrate the concept.
What’s included in manufacturing overhead costs?
Manufacturing overhead costs are indirect expenses that occur in producing goods or services. They are not directly related to the manufacture of a product but still need to be accounted for when calculating total manufacturing costs. Understanding these costs can help businesses determine their budgets and plan for future growth.
When reviewing manufacturing overhead, it is essential to consider what’s included.
Typical items included in this category include:
- Utilities
- Insurance
- Taxes
- Maintenance and repairs
- Rent and depreciation
- Financial costs (interest on loans)
Examples of manufacturing overhead costs include:
- Factory security
- Equipment lease payments
- Administrative salaries for those who oversee operations management and quality control
Fixed, variable, and semivariable overheads
All three types of overheads – fixed, variable, and semivariable – are essential for businesses to understand in order to accurately calculate the cost of production.
Fixed overhead costs
These are the expenses that stay the same even when production volume changes. For example, imagine you own a custom bike factory. The cost of your building rental, property taxes, and insurance are all fixed manufacturing overhead costs. Even if you make 100 bikes or 1,000 bikes, those costs will remain the same.
Semivariable overhead costs
Semivariable overhead costs may fluctuate with production levels but are not directly tied to them.
These semi-variable manufacturing overhead costs include things like utilities, packaging materials, and shipping fees. Although these costs can fluctuate depending on the number of orders being processed, ecommerce businesses can still get a handle on them by taking a closer look at their spending patterns. By understanding which changes in production volume most impact overhead costs, ecommerce businesses can better manage their bottom line.
Semi-variable manufacturing overhead costs can eat into profits if not managed carefully.
Variable overhead costs
Variable overhead costs increase or decrease in line with changes in output volume and can include materials used to produce a product, such as raw materials or packaging supplies.
Over the last few years, many ecommerce businesses have seen their products, components, and raw materials increase in price due to production hiccups and shipping delays impacted by the pandemic.
ecommerce businesses often have variable manufacturing overhead costs. This means that the cost of goods changes based on how many items are sold. For example, if an ecommerce business sells 500 dog sweaters, the variable costs might be $2 per sweater. But if the company sells 1,000 canine sweaters, the variable cost might be $1.50 per sweater. The ecommerce business can then use this information to price its products accordingly.
Variable manufacturing overhead costs can also help ecommerce businesses to keep track of their inventory levels. If the business knows that they have a specific fixed cost per sweater, it can easily calculate how many sweaters they need to sell in order to break even. This information can be used to make important decisions about production levels and product pricing.
In short, variable manufacturing overhead costs can be a helpful tool for ecommerce businesses. By understanding these costs, companies can better manage their inventory and pricing policies.
Manufacturing overhead formula
The formula used to calculate manufacturing overhead is:
Total Manufacturing Overhead Cost = Fixed + Variable + Semivariable Overhead Costs.
It is essential for businesses to have an accurate understanding of these three components when calculating total manufacturing costs in order to ensure they are on track with their budgets.
When looking at the difference between manufacturing overhead and total manufacturing cost, it is important to remember that the latter includes both fixed and variable costs associated with production, whereas the former does not. Therefore, total manufacturing costs will always be higher than manufacturing overhead alone.
What are the steps to calculate the manufacturing overhead?
To provide an example of how to calculate manufacturing overhead costs, let’s look at an ecommerce company producing kid-sized race cars for sale.
The company’s fixed overhead is $150,000 per month, and its variable overhead is $100 per unit produced. If they produce 500 units this month, their total manufacturing overhead cost would be calculated as follows:
Total Manufacturing Overhead Cost = Fixed + Variable + Semivariable Overhead Costs = 150,000 + (100 x 500) = $200,000.
Understanding manufacturing overhead costs is critical for businesses to remain financially stable and successful. By calculating their total overhead costs, businesses can ensure that they are making appropriate investments in the production process and keep their budgets on track. With this knowledge, companies can plan for future growth and make sound decisions about their operations.
What is the difference between manufacturing overhead and total manufacturing cost?
There’s a big difference between manufacturing overhead (MOH) and total manufacturing cost. The former refers to the indirect costs associated with running an ecommerce business, while the latter takes into account all of the costs associated with manufacturing products.
In order to get a better understanding of the difference, let’s take a closer look at each term. ecommerce manufacturing overhead includes costs such as rent, utilities, and payroll for employees who aren’t directly involved in the manufacturing process.
Total ecommerce manufacturing cost, on the other hand, encompasses all of the direct and indirect costs associated with manufacturing products. This includes things like raw materials, labor, and shipping.
So, what does this all mean for ecommerce businesses like yours? Well, it’s important to understand both types of costs in order to make informed decisions about pricing and profitability.
Manufacturing overhead calculation examples
For instance, an ecommerce business selling yearly planners and planner accessories has $2,000 in overhead costs per month and $5 in variable overhead per unit produced. If they sell 5000 planners this month, their total manufacturing cost would be:
Total Manufacturing Overhead Cost = Fixed + Variable + Semivariable Overhead Costs
2,000 + (5 x 5000) = $27,000
The allocation of costs is vital so that your ecommerce business can establish realistic figures for the cost of each unit (in this case, yearly planners) manufactured.
Let’s take a look at an ecommerce business selling affordable studio lights for YouTube creators.
The company’s fixed overhead is $15,000 per month, and its variable overhead is $100 per unit produced. If they produce 750 units this month, their total manufacturing overhead cost would be calculated as follows:
Total Manufacturing Overhead Cost = Fixed + Variable + Semivariable Overhead Costs = 15,000 + (100 x 750) = $90,000.
Manufacturing overhead is an essential part of running a manufacturing unit. Tracking these costs and sticking to a proper budget can help you to determine just how efficiently your business is performing and help you reduce overhead costs in the future.
Final thoughts
Manufacturing overhead costs can be tricky to calculate. But the first step to maximizing business metrics is first to understand them. Now with a bit of know-how and some helpful examples, you should be able to get a reasonable estimate for your business.
Looking for more business metrics to gauge how your ecommerce company is doing? See our blog posts on how to calculate the following metrics and their importance:
Remember, the goal is to have an accurate calculation of manufacturing overhead to make sound financial decisions for your company.
FAQs
Businesses can effectively track and manage semi-variable overhead costs by using detailed accounting software that can separate and categorize these costs accurately. Regularly reviewing and adjusting budgets to reflect changes in production levels also helps in managing these costs efficiently.
To reduce manufacturing overhead costs without compromising production quality, businesses can implement lean manufacturing principles, invest in energy-efficient machinery, and negotiate better terms with suppliers.
Manufacturing overhead costs impact pricing strategy and profitability by adding to the total production costs, which must be accounted for in the product pricing to ensure profitability. These costs can vary significantly across industries, affecting how each business sets its prices and assesses its profit margins.