How to Calculate Manufacturing Overhead Costs Step by Step

how to calculate factory overhead

In this article, we will discuss how to calculate manufacturing overhead and why it matters. The income statement and balance sheet must have COGS and inventory value. In our example scenario, for each dollar of sales generated by our retail company, $0.20 is allocated to overhead. Suppose a retail company is attempting to determine its total overhead for the past month.

Step 1: Identify and calculate indirect manufacturing overhead costs

This means 16% of your monthly revenue will go toward your company’s overhead costs. Your direct labor costs from machine operators and assembly line staff are already included in your cost of goods sold. Include monthly depreciation expense for the manufacturing equipment used in your manufacturing facility. Don’t include all depreciation expenses, only those directly related to production.

What are the different types of indirect costs related to manufacturing overhead?

If your company had 1,700 direct labor hours for the month, you would divide the overhead costs by the number of direct labor hours. For example, if you have a monthly depreciation expense of $1,600, and $1,000 of that is for manufacturing equipment, only include the $1,000 in your monthly manufacturing overhead costs. When you do this calculation and find that the manufacturing overhead rate is low, that means you’re running your business efficiently. The higher the percentage, the more likely you’re dealing with a lagging production process. Once you have identified your manufacturing expenses, add them up, or multiply the overhead cost per unit by the number of units you manufacture. So if you produce 500 units a month and spend $50 on each unit in terms of overhead costs, your manufacturing overhead would be around $25,000.

Manufacturing Overhead Formula

Manufacturing overhead costs do not include administration and advertisement expenses. Manufacturing overhead is an essential part of running a manufacturing unit. Tracking these costs and sticking to a proper budget can help you to determine just how efficiently your business is performing and help you reduce overhead costs in the future.

Fixed, Variable, and Semi-Variable Overhead Costs

  1. You can calculate manufacturing overhead costs by adding your indirect expenses, such as direct materials and labor, into one total.
  2. Our timesheet feature is a secure way to track the cost and the time your team is putting into completing their tasks.
  3. These are costs that are incurred for materials that are used in manufacturing but are not assigned to a specific product.
  4. You also need to closely monitor your production schedule so you can make adjustments as needed.
  5. For example, if your company has $80,000 in monthly manufacturing overhead and $500,000 in monthly sales, the overhead percentage would be about 16%.

It also requires a continuous supply of electricity and factory resources to carry on its processes smoothly. The allocation of costs is necessary to establish realistic figures for the cost of each unit manufactured. Editorial content from The Ascent is separate from The Motley Fool editorial content and is created by a different analyst team. Sandra Habiger is a Chartered Professional Accountant with a Bachelor’s Degree in Business Administration from the University of Washington.

You add the hourly rate of your work and then assign their hours, which will then populate the Gantt and the sheet view (like the Gantt but without a graphic timeline). You can also track non-human resources, such as equipment, suppliers and more. To calculate your allocated manufacturing overhead, start by determining the allocation base, which works like a unit of measurement. We help small businesses increase their efficiency with user-friendly inventory management software. From running health checks on your inventory and accounting systems to sharing relevant formulas to crunch the numbers, we’ve got your efficiency needs covered. Manufacturing units need factory supplies, electricity and power to sustain their operations.

Accurately calculating your company’s manufacturing overhead costs is important for budgeting. Including only direct or “operational” expenses in your financial plan can leave the company in a major cash crunch, as every business in every industry has to incur some overhead costs. Calculating these beforehand can help you plan better and reduce unexpected expenses. To calculate the true cost of a manufactured item you need to calculate and allocate manufacturing overhead. Add all indirect costs and then determine the percentage of the cost that needs to be allocated to your final manufacturing overhead costs.

There are a few business expenses that remain consistent over time, but the exact amount varies, based on production. For example, companies have to pay the electricity bill every month, but how much they have to pay depends on the scale double entry accounting of production. For instance, during months of heavy production, the bill goes up; during the off season, it goes down. Manufacturing Overhead costs are the indirect factory-related costs utilized at the time of manufacturing a product.

how to calculate factory overhead

As we mentioned above you can track costs on the real-time dashboard and real-time portfolio dashboard, but you can also pull cost and budget data in downloadable reports with a keystroke. Get reports on project or portfolio status, project plan, tasks, timesheets and more. All reports can be filtered to show only the cost data and then easily shared by PDF or printed out to use update stakeholders.

To compute the overhead rate, divide your monthly overhead costs by your total monthly sales and multiply it by 100. These two amounts seldom match in any accounting period, but the variance will generally average to zero after multiple quarters. If this variance persists over time, adjust your predetermined overhead rate to align it more closely to actual overhead figures reported in your financial statements. The labor hour rate is calculated by dividing the factory overhead by direct labor hours. When setting prices and making budgets, you need to know the percentage of a dollar allocated to overheads.

It’s just as important not to include unrelated expenses, which can result in difficult-to-move, overpriced inventory. This is an important, core principle which you can master to improve your business. Manufacturing overhead includes any cost related to a completed product, not considered a direct cost. ProjectManager is award-winning work and project management software that connects hybrid teams with collaborative to the core tools and a single source of truth. With features for task and resource management, workload and timesheets, our flexible software can meet the needs of myriad industries. Join the teams at Seimens, Nestle and and NASA that have already succeeded with our tool.

Make a comprehensive list of indirect business expenses, including items like rent, taxes, utilities, office equipment, factory maintenance, etc. Direct expenses related to producing goods and services, such as labor and raw materials, are not included in overhead costs. Knowing your manufacturing overhead rate can be helpful when integrating data into ​​inventory management software. Manufacturing overhead, also known as factory overhead or manufacturing support costs, is the indirect cost of the production process. This can include expenses such as a supervisor’s salary or the annual lease of your production facility. To allocate manufacturing overhead costs, an overhead rate is calculated and applied.


Leave a Reply

Your email address will not be published. Required fields are marked *