The underlying objective of running a business in any situation is to accrue profits. But how is profit defined in the context of a manufacturing business? A simple formula to calculate profit is as below:

Profit = (Price – Variable Cost) * Quantity – Fixed Cost

Variable Cost are all costs that are related to the quantity of products produced such as direct material cost, direct labor costs, reject rates etc.

Fixed Cost are defined as the manufacturing and indirect costs required to produce your products. These can be rent or mortgage for your factory ad office, utility bills etc.

It is a simple and straightforward looking formula to calculate profit for your business. At first glance you may think that you can easily increase your profits by adjusting some of the variables such as increasing your price or reducing variable costs. However, is it really that straightforward?

Staying competitive in such an ecosystem is exceptionally tough, playing price war with your competitors will only serve the entire industry adversely in the long run. The more sensible way to stay competitive is to be able to efficiently manage your manufacturing costs.

It is easier said than done, which leads us to discuss 7 effective ways you can use to manage and lower your manufacturing costs later in this article.

Before that, let us define what is manufacturing cost. It is the cost incurred to procure raw materials and produced finished products out of it. This means that all factory related costs are included in manufacturing cost.

Manufacturing Cost = Direct Machine & Material Cost + Direct Labor Cost + Overheads

Direct Machine & Material Cost is the cost incurred to acquire and run machines, purchase raw materials and it also includes logistics expenses to bring in the raw materials.

Direct Labor Cost is the cost incurred to hire workers to produce finished products using purchased raw materials.

Overheads are miscellaneous costs incurred in the factory and excludes the above two costs. They are indirect manufacturing expenses that are not easily allocated directly to the price of a product.

Examples of Overheads are factory rental, utility bills related to the operation of the factory, insurance, quality control, internal logistics, production admin to name a few.

 

Efficient Ways to Manage Manufacturing Costs

Track Key Expenses
These are the basic numbers you should be tracking. Start recording your key expenses today if you are not doing it already. This is because you cannot manage something which is not recorded.

Now, you can do it the traditional and manual way by using spreadsheets, or you can choose to implement an ERP system to help you keep tabs on these numbers.

Lower Direct Material Cost
A substantial portion of your total manufacturing costs is usually made up of direct material cost. If you have a fully integrated ERP system that is capable of helping you estimate quantities needed over at least six months or a year, then you may be able to enter into long term contracts and negotiate a better price with your suppliers.

If you have full visibility on all your direct material costs, then consider replacing expensive raw materials with cheaper alternatives that do not compromise on quality.

Lower Held Inventory
Inventory you hold onto incurs storage and maintenance costs such as stock taking, opportunity cost, insurance etc. To lower your held inventory requires efficient management of production capacity, and inventory management.

Consider using Just-in-Time method to avoid over-stocking raw materials. The goal is to lower inventory levels to an optimum level that minimizes carrying cost but does not adversely affect production schedules.

Increase Production Efficiency
Employee efficiency and Overall Equipment Efficiency (OEE) can be optimized to be more productive. Lower machine down-time, producing more units per process and making sure production lines run at optimum level will indirectly help to lower your manufacturing cost, resulting in more competitive pricing for your products.

Assuming you have 5 production workers with a total monthly salary of RM10,000. If they are able to produce 1,000 units of finished products a month, the direct labor cost would be RM10 per unit.

Now if production efficiency were increased and your final output per month increased by 20% more units, that would mean 1,200 units can be produced each month. The labor cost per unit as a result of the increased efficiency would come up to RM8.33 instead of RM10 per unit. That is a massive improvement!

Manage Overheads
These are usually non-value-added expenses and should be avoided if possible. Again, this requires good data for thorough analysis to be done.

These costs are difficult to control without a fully integrated ERP system that is able to pull in data from different departments into a consolidated report. If you do not have a system, the next best solution would be to use spreadsheets, though these can be prone to human error and other unforeseen issues.

Implement Automation
There are technologies to automate various manufacturing tasks to make them more efficient. The goal here is to automate redundant tasks such as picking, sorting, and cleaning, as well as reduce human errors to the bare minimum and possibly increase production rates as well.

You will need to make a sizable initial investment in sophisticated machines, but this will more than pay off in the long run.

Integrate and Automate Business Processes
This is another technology investment much like the previous point, but the system here is meant to integrate the various business processes and departments together.

A good ERP system will not only integrate and automate business processes, it is also able to make predictions and estimations that help in areas such as capacity planning, estimate delivery time, and do pre- and post-calculations.

We hope you can put the above suggestions for efficiently managing manufacturing costs to good use in your manufacturing business.

Many of the suggestions above work best when you have a complete and fully integrated ERP system such as MONITOR G5 implemented for your business. You may contact us to book a demo and we will be able to show you the full capabilities of our system.