8 Best Practices for Manufacturing Cost Management

When considering managerial or cost accounting, something that is going to come up frequently is the notion of manufacturing cost management. When you think about manufacturing costs, you should be cautious because you are going to use them when calculating the cost of goods sold (COGS). And so, you must have a fundamental understanding of what manufacturing costs are.

Manufacturing cost in its elements

Manufacturing costs can be defined as a representation of only the expenses incurred in making a product and therefore do not include things like administrative expenses. 

In accounting, it encompasses several tasks that influence each unit of production and inventory valuation. As defined, the manufacturing cost has three major elements:

• Direct material
• Direct labor
• Manufacturing overhead

Considering a manufacturing company that makes cars, these elements can be defined as:

Direct materials– These are the raw materials that go directly into a final product. Say the manufacturing company makes a car body from steel; the manufacturing overhead includes steel and other associated materials. 

Direct labor– This encompasses labor that can be traced to individual units produced. Consider a car coming off an assembly line; you can say that a specific person helped assemble that car,. Hence the direct labor cost includes the work they did, such as assembling a door. 

Manufacturing overhead– All manufacturing costs that are not direct labor or direct materials are overhead. The janitor in a car assembly line is indirect labor. For indirect materials, they include all the materials used to put together the direct materials in production. For example, silicone glue used to put together a rearview mirror.

Read more about costs in your company:

4 types of logistics costs you should keep track of

3 key factors of supply chain sustainability

4 types of simulation models to leverage in your business

Accounting in Manufacturing Cost Management

Through recording, analyzing and reporting costs to management, you can bring insights to your manufacturing cost management while maintaining compliance with accounting standards. The elements of cost accounting in manufacturing include;

• Inventory valuation– This is the total cost of the inventory at the end of an accounting period, which is required to place accounting standards on correct inventory valuation. FIFO, LIFO and standard cost are the methods you could use to assign valuation to an inventory.
• Cost of goods sold (COGS) valuation– This cost tracking involves direct product costing (costs that vary with changes in revenue) and absorption costing (full allocation of overhead costs). Hence both the cost of materials and cost of manufacturing are accounted for. 
• Margin analysis– It involves making a compilation of all product associated costs and subtracting them from the revenue of the products to get a margin of each product. Margin analysis is slowly paving the way for constraint analysis since most manufacturers now realize that including target costs to margin analysis can lead to inaccurate decisions in selling a product.
• Constraint analysis– This constitutes finding the bottleneck in the manufacturing process and advising on the impact on the throughput of changes through that bottleneck.
• Variance analysis– It involves finding the cause of variances when comparing actual costs incurred to budgeted costs associated with material labor and overhead.
• Budgeting– The production manager uses the information derived from the above analyses and uses it as a basis for the annual manufacturing area budget.

8 practices to help you maximize cost management and stay lean

Here are a few ways to improve on the control of your manufacturing cost management.

1. Track the numbers – Tracking important factors through accounting systems is key in manufacturing cost management.
2. Optimize your workforce – Use a demand-calibrated approach rather than a capacity-utilization approach.
3. Reduce the carrying cost of inventory – Adjust your manufacturing processes to cater directly to client demand. This avoids excess inventory or underproduction.
4. Control manufacturing overheads
5. Lower your regulatory compliance costs – This can be achieved by real-time monitoring and the use of an optimized system.
6. Keep your energy utilities to a minimum – Conduct energy audits to minimize energy losses.
7. Focus on transportation management -Transportation costs can account for up to 10% of the total company revenue. Using efficient logistics services is fundamental if you want to reign in this expense. 
8. Leverage Automation – the automation process increases efficiency while saving on labor costs as well as general and administrative costs. 

How simulation boosts cost management and big data

Simulation for manufacturing cost management involves the use of computer software to model a real production system. Through simulation, you can optimize and validate insights leveraged by big data by establishing a virtual simulation environment. This, in turn, boosts the quality of the eventual finished products. 

Through experimenting and analyzing manufacturing processes in a virtual environment, the cost and time taken by physical testing are reduced. This helps cut overall manufacturing costs and drives efficiency. 

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