When running a manufacturing business, many costs go beyond the raw materials and direct labor used to produce goods. These additional costs are collectively known as manufacturing overhead. Understanding and managing manufacturing overhead is essential for small business owners and manufacturers, as it directly impacts profitability and pricing strategies.
Ahead, discover more information on manufacturing overhead, including a quick formula to calculate your own.
What Is Manufacturing Overhead? How Do You Calculate It?
So, what is manufacturing overhead, and how is it calculated? Let’s break it down.
Manufacturing overhead includes the indirect expenses required to keep a production facility running smoothly. These costs aren’t tied to specific units like raw materials or labor but cover essentials such as factory utilities, machine maintenance, equipment depreciation, and supervisory salaries.
For example, a custom furniture maker treats wood and labor as direct costs. However, electricity to power tools, equipment depreciation, and supervisor salaries all fall under overhead. Managing these costs can be challenging, especially for small business owners or startups without dedicated teams or the capital to run their own facilities long-term.
That’s why many entrepreneurs choose to partner with contract manufacturers. A startup producing eco-friendly kitchen gadgets, for instance, may outsource production to avoid the burden of managing overhead. This approach reduces startup costs and allows the business to focus on growth areas like branding, product development, and sales.
Key Components of Manufacturing Overhead
Product manufacturingoverhead covers a range of operational costs, including indirect materials, facility expenses, equipment costs, and salaries. Indirect materials consist of items such as lubricants for machinery, cleaning supplies, and replacement parts for production equipment. Facility expenses cover rent for the production space, utilities (like electricity, water, and heating), and property taxes associated with the manufacturing facility.
Equipment costs include machinery depreciation and maintenance or repair expenses. Salaries cover non-production staff like supervisors, quality inspectors, and janitors. For example, a bakery’s direct costs are flour and sugar, while overhead includes oven maintenance, electricity, and janitorial wages.
How To Calculate Manufacturing Overhead
To determine manufacturing overhead, tally up all indirect costs over a specific period, like a month or quarter. Then, calculate the overhead rate, which distributes these costs across production. Use the following formula:
Overhead Rate = Total Manufacturing Overhead
Total Direct Labor Hours or Machine Hours
For example, if a company incurs $50,000 in overhead monthly and employees work 2,500 direct labor hours, the overhead rate is$20 per direct labor hour. This rate helps businesses incorporate overhead into pricing strategies for greater profitability.
The Importance of Managing Manufacturing Overhead
Failing to track overhead can lead to underpricing products and miscalculating expenses—critical mistakes for manufacturers. Regularly reviewing and optimizing these costs improves efficiency and reduces unnecessary spending. For example, upgrading to energy-efficient equipment or refining facility management lowers expenses and boosts profitability.
Understanding how manufacturing overhead is calculated is essential for optimizing costs. By maintaining accurate records, controlling manufacturing overhead, and streamlining operations, manufacturers can price products effectively and strengthen their market position. Partnering with Product QuickStart grants access to expert insights and tools that will help you manage your manufacturing overhead, improve efficiency, and drive business success.
