Calculate The Manufacturing Overhead Formula

Why Does Manufacturing Overhead Matter?

Manufacturing overhead (MOH) encompasses all the indirect costs associated with running a production facility. These are expenses that contribute to the production process but cannot be directly tied to a specific unit of output. Examples include factory lighting, salaries for supervisors, and machine maintenance.

For business owners and event managers, accurately calculating MOH is paramount for several reasons:

  1. Profitability: MOH is a significant component of total production cost. Understanding these indirect expenses allows for accurate pricing of your products or services, ensuring you factor in all expenses and maintain a healthy profit margin.
  2. Cost Control: By analyzing MOH, you can identify potential areas for cost reduction. Perhaps renegotiating supplier contracts for indirect materials or implementing energy-saving measures can lead to significant savings.
  3. Informed Decision Making: Understanding overhead costs allows for better planning and budgeting. If you anticipate increased production, you can predict the impact on your overall overhead and allocate resources accordingly.
  4. Competitive Pricing: Knowing your total production cost, including MOH, enables you to set competitive prices in the market while ensuring your business remains profitable.

A Breakdown of Manufacturing Overhead Costs

Manufacturing overhead is a composite of various indirect costs. Let's break down the key components:

  1. Indirect Materials: These are consumable items used throughout production but not directly incorporated into the final product. Examples include lubricants for machinery, light bulbs, cleaning supplies, and safety equipment.
  2. Indirect Labor: This refers to the salaries and wages of factory personnel who don't directly assemble the product. This includes quality control inspectors, supervisors, maintenance technicians, security guards, and administrative staff.
  3. Other Overheads: This category encompasses a wide range of expenses essential for running the factory. It can include:
  • Utilities: Electricity, water, and gas used to power the facility.
  • Rent or Lease Payments: The cost of leasing or owning the factory building.
  • Depreciation: The gradual decrease in the value of machinery and equipment over time.
  • Maintenance and Repairs: Costs associated with maintaining and repairing factory equipment.
  • Insurance: Factory property and liability insurance.
  • Property Taxes: Taxes levied on the factory building and equipment.

Manufacturing Overhead Formula: How to Calculate the Costs

Now that we understand the components, let's explore how to calculate manufacturing overhead. Total Manufacturing Overhead (MOH) Cost Formula: Total MOH Cost = Indirect Materials Cost + Indirect Labor Cost + Other Overhead Costs

MOH Cost Example:

A bicycle manufacturer incurs the following indirect costs in a month:
  • Indirect Materials: $2,000
  • Indirect Labor: $10,000
  • Utilities: $5,000
  • Rent: $3,000
  • Depreciation: $2,000
Total MOH Cost = $2,000 + $10,000 + $5,000 + $3,000 + $2,000 = $22,000
If the manufacturer produced 1,000 bicycles in that month, the MOH cost per unit would be:
MOH Cost per Unit = $22,000 / 1,000 units = $22 per unit
This means that for every bicycle produced, the manufacturer incurs an additional $22 in indirect costs.
MOH Cost Formula Per Unit:

Gather Data: Collect data on all your indirect manufacturing expenses for a specific period (e.g., month, quarter, year).
Calculate Total MOH Cost: Use the formula above to find the total MOH cost during the chosen period.
Determine Production Volume: Find the total number of units produced during the same period.
Calculate MOH Cost per Unit: Divide the total MOH cost by the total number of units produced.

Understanding the Manufacturing Overhead Rate

The manufacturing overhead rate (OH rate) is a key metric that expresses MOH as a percentage of direct labor cost or machine hours. It helps to simplify the allocation of overhead costs to individual units of production.
There are two main ways to calculate the overhead rate:

1. Based on Direct Labor Cost:

OH Rate = (Total MOH Cost) / (Total Direct Labor Cost) x 100
Let's revisit the bicycle manufacturer example. Assume the total direct labor cost for the month was $30,000.
OH Rate = ($22,000) / ($30,000) x 100 = 73.33%
This indicates that for every $1 of direct labor cost, the manufacturer incurs an additional $0.73 in overhead costs.

2. Based on Machine Hours:

OH Rate = (Total MOH Cost) / (Total Machine Hours)
Machine hours represent the total time that production machines are operational. Calculating this metric requires tracking machine usage data.
By having the OH rate, you can estimate the overhead cost associated with producing a single unit based on its direct labor cost or machine hours. This simplifies cost allocation and production planning.

Strategies to Optimize MOH Costs

While MOH is an inevitable part of manufacturing, there are strategies to manage and potentially reduce these costs:

  1. Embrace Efficiency: Implement energy-saving measures like using LED lighting, optimizing production processes to minimize machine idling, and scheduling maintenance during off-peak hours.
  2. Renegotiate Contracts: Regularly review supplier contracts for indirect materials and utilities. Negotiating better pricing or exploring alternative vendors can lead to significant savings.
  3. Invest in Automation: Consider automating repetitive tasks currently performed by indirect labor to streamline operations and potentially reduce labor costs. However, carefully weigh the cost of automation against the potential long-term benefits.
  4. Embrace Technology: Modern accounting software can automate data collection and calculations, simplifying MOH tracking and analysis. Additionally, inventory management software can help optimize inventory levels, reducing storage costs and waste.

In Conclusion…

By understanding, calculating, and effectively managing manufacturing overhead, businesses can gain a significant competitive advantage. Here are some key takeaways:
  • MOH is a crucial component of total production cost, and accurately calculating it ensures profitability.
  • Analyzing MOH helps identify areas for cost reduction and optimize resource allocation.
  • The manufacturing overhead rate simplifies the allocation of overhead costs to individual units.
  • Implementing strategies like energy efficiency and automation can help control MOH.
Now that you're armed with this knowledge, it's time to assess and potentially optimize your own manufacturing overhead calculations. Revisit your current cost structure, identify areas for improvement, and explore strategies to streamline your operations. Remember, even small reductions in overhead costs can significantly impact your bottom line.

Need Help Managing Your Manufacturing Overhead?

The complexities of manufacturing overhead can be daunting, but you don't have to go it alone. The Sourcing Co. can be your partner in navigating these challenges.

The Sourcing Co. provides comprehensive product sourcing and manufacturing solutions designed to empower business owners and event managers to:

Our expertise in all aspects of manufacturing, from product development to logistics, ensures that clients can:

  • Gain a deeper understanding of their manufacturing overhead costs.
  • Develop strategies to effectively manage and potentially reduce MOH, including optimizing shipping and logistics.
  • Make informed financial decisions based on accurate cost data.
  • Increase overall operational efficiency and profitability.

Don't let manufacturing overhead become a burden on your business. Contact The Sourcing Co. today and discover how our expertise can help you achieve greater control and cost savings!