Total manufacturing cost is the metric used to describe the amount your business will spend to manufacture its products. Knowing your total manufacturing cost will help you make better budgeting decisions, find a manufacturing partner, and price your final product for customers.
This guide will help you calculate the costs of manufacturing your product, including what elements to consider and some cost-tracking tools that make life easier.
What are manufacturing costs?
Manufacturing costs are defined by Investopedia as “all of the direct and indirect costs businesses face from manufacturing a product or providing a service.”
Confusingly, the “cost of goods manufactured” and the “cost of goods sold” are two other metrics that sound similar but refer to different cost categories on an income statement.
Your total manufacturing cost is the total amount of direct material costs, direct labor, and manufacturing overhead spent in a time period.
Cost of goods manufactured only counts products finished during the time period. When the period ends, any unfinished products—those still in production—are considered works in progress. For accounting purposes, these costs are categorized separately.
Cost of goods sold (COGS) is defined only as the manufacturing costs associated with products sold during the time period. This metric excludes any unsold units while still considering the cost of goods manufactured.
Knowing these separate terms is important for accounting, not for vetting different manufacturing partners or setting up your financial forecasts. Total manufacturing cost is the primary metric you’ll need to know for budgeting and planning resource allocation.
Finally, it’s also worth drawing a line between production costs and manufacturing costs. "Production cost refers to all of the expenses associated with a company conducting its business, while manufacturing cost represents only the expenses necessary to make the product," wrote Investopedia.
[Read more: Looking for a Manufacturing Partner? 7 Key Industry Terms to Know]
How to calculate manufacturing costs
There are three components to total manufacturing cost: direct materials, direct labor, and manufacturing overhead. These types of production costs, added together, make up the cost of manufacturing your product. Here’s what these types of production costs mean in practice:
- Direct materials: The raw materials that go into creating the final product.
- Direct labor: Expenses related to the employees who create the final product.
- Manufacturing overhead: Any costs related to the manufacturing process that aren’t direct materials costs or labor costs.
Direct materials costs should be distinguished from indirect ones. “Indirect costs do not feature directly in manufacturing the finished product, such as general factory supplies and indirect labor,” wrote the experts at MasterClass. “Indirect costs might also include materials that are part of the finished product but in insignificant amounts per production unit.”
Direct labor costs aren’t limited to simple salary tallies. Direct labor costs may include holiday pay, workers’ insurance, sick leave, and payroll taxes.
Finally, manufacturing overhead is a little trickier to define. “Unlike the other costs, this is a broad category that includes many different items, such as utilities, equipment, etc.,” wrote ProjectManager. “Therefore, first, one must identify these costs, such as the indirect labor and materials costs, add depreciation costs and all other manufacturing overhead costs to get your figure.”
Your total manufacturing cost is the total amount of direct material costs, direct labor, and manufacturing overhead spent in a time period.
Fixed vs variable costs and how they affect product pricing
Adding two more financial terms into the mix, fixed costs and variable costs, can help you figure out how to set per-product prices and estimate bulk pricing for high-volume customers.
Fixed costs are those that remain constant regardless of your sales or production levels—think rent, insurance, salaried wages, and loan payments—while variable costs change in direct proportion to how much you produce or sell.
Distinguishing between the two is essential for budgeting effectively, setting prices, costing individual jobs or orders, and strategizing for future growth. Ideally, you should set your price to cover the variable cost of producing each unit, plus enough margin to cover your fixed costs and generate profit.
Do this by calculating your break-even point—the moment revenue equals total costs. The break-even calculation is:
Break-Even Point = Fixed Costs / (Revenue – Variable Costs)
Armed with this information, you can determine exactly how many units you need to sell to break even, and you can offer promotions or bulk discounts without inadvertently operating at a loss.
How to reduce manufacturing costs without hurting quality
Reducing manufacturing costs doesn’t have to mean cutting corners. One of the most proven ways to lower expenses is a practice known as lean manufacturing, which targets waste at every level of production. Lean practices help businesses slash production costs by limiting overproduction and reducing idle time. Industry studies show manufacturers can reduce costs by 5% to 20% in the first year alone—while actually improving quality metrics like defect reduction by 25% to 90%.
On the supply side, renegotiating with suppliers, exploring bulk discounts, and working with multiple vendors can lower material costs without sacrificing quality—a practical first step that requires no capital investment. These small process improvements can make a big difference.
Small businesses can also find significant savings in how they manage inventory and energy. Implementing just-in-time inventory systems reduces excess stock and minimizes the risk of spoilage or obsolescence, lowering both storage and material costs. Conducting an energy audit to identify where consumption is highest, from inefficient lighting to outdated machinery, and then upgrading to energy-efficient equipment can lead to significant savings over time
Finally, embracing a culture of continuous improvement, often associated with the Kaizen approach, encourages employees at all levels to seek ways to enhance processes, leading to small, incremental changes that over time result in significant cost savings and quality improvements alike.
Use a tool to calculate your manufacturing costs
Fortunately, there are software tools that can help you better understand these types of production costs and calculate your total manufacturing cost. Look for enterprise resource manufacturing resource planning (MRP) tools designed to manage production planning, scheduling, and inventory control.
Some popular MRP tools for small businesses include Fishbowl, MRPEasy, and Odoo. There are also enterprise resource planning tools (ERP) that can integrate business functions, including finance, HR, sales, and manufacturing, to give you an overview of costs across the organization.
[Read more: How to Find a Factory to Manufacture Your Product]
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