The common challenge for all the manufacturers is discerning the actual costs necessary to produce finished goods. The importance of identifying the correct cost of the produced goods cannot be understated. Manufacturing companies that are able to accurately account for the inventory costs will be in a better position to analyze the gross profit. Gross profit analysis is designed to identify the reasons why the gross gain margin changes from time to time so that the management is able to take action and bring the gross margin in line with expectations. Obviously, the decline in the gross profits could indicate a serious issue either in the sales, materials, labor, or overhead, and so the impact of this figure is highly depended upon. Accounting for all the manufacturing costs in your inventory is very effectual in your business.
There are 2 Primary Cost Groups – Direct and Indirect Costs – That Come to Play
Direct Costs – Particularly related to the production or the procurement of an item, be it the cost from the vendor or the cost of labor to produce the item.
Indirect Costs – It is used by multiple activities and is needed to run the company. Some examples are electricity, rent, and administrative expenses.
How Do You Even Know What to Charge to Clients, or What Kind of Profits You’re Seeing?
The major element in the manufacturing environment is too often to overlook is the calculation of the direct labor costs that are associated with the manufacturing method. Their lies are the problem: If manufacturers are not tracking the direct labor costs, how do they know what to charge clients? Perhaps what’s worse, how do they maintain the acceptable gain margin?
If you operate within the manufacturing sector and have been on the fence about the tracking of the direct labor costs, you’ve stumbled upon the right blog. Here, we’re going to explore the reasons why direct costing is not tracked (or not tracked accurately), the importance of tracking labor costs, the components that comprise calculating labor costs and more. By the time we’re finished, you’ll have a much better grasp on the direct labor costs and their relationship with the manufacturing method.
The Reasons Why Direct Labor is not Tracked
In as succinct a way as possible, we’re going to go over the primary reasons why direct labor isn’t always tracked:
- It’s Too Complicated – We hear this all the time; one individual at the company may be running the multiple jobs at the same time…so who exactly is allocating the time accordingly?
- Shops Employ the Guesstimate Method – While shops may think they are tracking the labor costs, all they’re doing is guessing.
- Shops Utilize Paper-Based Methods – When a paper-based process takes hold, the staff will ultimately guess or forget, resulting in inaccurate time logs.
- Shops Don’t Know How to Track Time – So they simply don’t do that.
The Importance of Tracking Labor Costs In Direct Costing
Without tracking the labor costs, manufacturing processes suffer in the myriad of ways; here are some examples:
- Overstaffing and understaffing of production lines lead to unnecessary labor costs or delays in production (and thus reduced cash flow).
- Reduced manufacturing throughput.
- Increased maintenance and administrative costs.
- Increased overhead costs that can affect profitability.
To that end, the implementation of tracking the labor costs enables the organizations to:
- Charge the proper amount for the work performed.
- Maintain profit margins.
Components That Makeup Calculating Labor Costs
The manufacturing labor costs are related with the laborers in a shop who work on the goods you’re manufacturing it directly; it’s important to measure the cost for the business, as this is essentially the direct measure of how much of your manufacturing costs are going towards the paying your laborers. What’s more, knowing this can support you when making decisions, especially when analyzing the efficiency of your operations.
The formula is simple: You identify all your direct laborers and then compute their total wages. In so doing, you:
- Determine Who Are Direct Laborers – The good rule of thumb is to count anyone as the direct laborer if they work directly on the product being manufactured.
- Calculate Hours in the Production Process – you should unravel that how many hours every direct laborer has invested in a production method from beginning to end; Direct Costing once you determine the total number of hours for each individual worker, simply include the hours to arrive at a total.
- Discover the Total Direct Labor Costs – Direct Costing Here, you take the total number of hours worked and multiply that by the hourly wage.