Manufacturing costs are everything a business spends to turn materials into finished goods: direct materials, direct labour and production overheads. Added up and divided by the units made, they give the cost of one product. That number decides your price, your profit and the value of the stock in your store.
This guide costs one school desk, line by line, at a Kampala workshop in Uganda shillings. It shows the overhead rule that keeps a slow month from inflating your price. It ends with where to save and how a small maker tracks it all in ArmPOS.
What are the three manufacturing costs?
The three manufacturing costs are direct materials, direct labour and manufacturing overhead. Materials and labour can be traced to each unit; overhead is shared across everything the workshop makes.
| Cost | What it covers | In a furniture workshop |
|---|---|---|
| Direct materials | Materials that become part of the product, offcuts included | Timber, plywood, varnish |
| Direct labour | Pay for the work done on each unit | A carpenter and a finisher, each paid per desk |
| Variable overhead | Indirect costs that rise and fall with output | Glue, nails, sandpaper, machine power and generator diesel |
| Fixed overhead | Indirect costs that stay the same whatever the output | Workshop rent, the supervisor's salary, machine depreciation and servicing, the night guard |
| Not a manufacturing cost | Selling, administration and finance | The showroom, sales commission, delivery to schools, the bookkeeper, interest on the machine loan |
The IFRS for SMEs Accounting Standard draws the same lines. Its paragraph 13.8, set out in the IFRS Foundation's module on inventories, names "depreciation and maintenance of factory buildings and equipment" as fixed overheads. Its variable overheads include "indirect materials and indirect labour".
Paragraph 13.13 keeps selling costs, and office overheads that don't help make the goods, out of their cost. The module's own worked example treats interest on an equipment loan as a finance cost, not a production cost.
Two subtotals come up in costing. Prime cost is direct materials plus direct labour; conversion cost is direct labour plus overhead, what it takes to turn the materials into a product.
How to calculate manufacturing costs for one product
Manufacturing cost per unit = direct materials + direct labour + variable overhead per unit + (fixed overhead ÷ normal output). Work it for one product at a time, with the prices you really pay.
For example, a workshop in Kampala makes two-seater school desks and sells them to schools at UGX 210,000. It normally makes 200 desks a month. The figures are illustrative, not a real workshop's.
| Cost | Line | UGX |
|---|---|---|
| Direct materials | Timber for the frame and bench: 6 planks at 12,000 | 72,000 |
| Direct materials | Plywood for the top and shelf: half a sheet at 56,000 | 28,000 |
| Direct materials | Varnish | 6,000 |
| Direct labour | Carpenter, paid per desk | 25,000 |
| Direct labour | Finisher, sanding and varnishing, paid per desk | 5,000 |
| Variable overhead | Glue, nails and sandpaper | 4,000 |
| Variable overhead | Machine power and generator diesel | 3,000 |
| Fixed overhead | 4,200,000 a month ÷ 200 desks | 21,000 |
| Total | Manufacturing cost of one desk | 164,000 |
The fixed overhead is the month's rent (1,800,000), the supervisor (1,200,000), machine depreciation (600,000), servicing (200,000) and the night guard (400,000). Together they come to UGX 4,200,000 a month, whatever the workshop makes.
At UGX 210,000, each desk leaves UGX 46,000 of gross profit, a margin of 21.9%. The difference between that margin and the 28.0% markup is worked in markup vs margin.
Materials are 64.6% of the desk's cost, labour 18.3% and overhead 17.1%. That split tells you where a saving counts most.
Cost the materials you buy for one desk, not just the wood left in it. Offcuts are normal waste, and normal waste belongs in the product's cost. Value each material at its landed cost, as raw materials inventory explains.
Why a slow month must not raise the cost of each unit
Spread fixed overhead over your normal output, not over what you made this month. IFRS for SMEs paragraph 13.9 says the fixed overhead per unit "is not increased as a consequence of low production or idle plant".
Normal capacity, in the standard's words, is the output "expected to be achieved on average over a number of periods or seasons under normal circumstances". For the desk workshop, that is 200 desks: its average month over a year of school terms and holidays.
| Month | Desks made | Fixed overhead per desk | Carried by the desks | Expense of the month |
|---|---|---|---|---|
| Normal | 200 | 21,000 | 4,200,000 | 0 |
| Slow: power cuts and few orders | 120 | 21,000 | 2,520,000 | 1,680,000 |
| Busy: abnormally high output | 280 | 15,000 | 4,200,000 | 0 |
In the slow month, dividing by the 120 desks made would put UGX 35,000 of overhead on each desk and its cost at UGX 178,000. The margin would seem to fall to UGX 32,000, and the owner might raise prices just when orders are scarce.
The UGX 1,680,000 that no desk carries is the cost of idle capacity, an expense of that month. The fix is more work in slow months, such as benches or office tables, not a higher price on desks.
In the busy month, the overhead per desk falls to UGX 15,000. Paragraph 13.9 lowers it in abnormally high production, so the desks are never valued above what they cost.
Manufacturing costs vs cost of goods sold
Manufacturing costs are what you spend making goods in a period; cost of goods sold is the cost of the goods you sold in it. A desk's full cost sits in stock until it sells, then becomes cost of goods sold.
In the normal month, the workshop spends UGX 32,800,000 making 200 desks. When 180 sell, cost of goods sold is UGX 29,520,000, and the other 20 desks stay in stock at UGX 3,280,000.
Production overheads are part of cost of goods sold, because paragraph 13.8 makes them part of each unit's cost. The full formula, with opening and closing stock, is in how to calculate cost of goods sold.
Where to cut manufacturing costs
Cut where the money is: materials first, then idle capacity, then power. Measure each one per unit before and after, so a saving shows up as a number.
| Change | What to measure | Before | After | Saved a month at 200 desks |
|---|---|---|---|---|
| Plywood cut from a drawn cutting plan | Sheets per desk | 0.5 | 0.4 | 1,120,000 |
| Machine work done while the grid is on | Power and diesel per desk | 3,000 | 2,000 | 200,000 |
Together the two save UGX 6,600 a desk, 4.0% of its cost, and UGX 15,840,000 a year at normal output. The desk's margin rises from 21.9% to 25.0%, and neither change needs a new machine.
Materials: plan the cuts, then hold every run to the plan
Cutting by eye, piece by piece, is how half a sheet per desk became normal in the example. A plan drawn once fits the parts for five desks into two sheets.
Write the plan into a bill of materials, so every run can be checked against what it should have used.
Idle capacity: fill the slow months
The slow month's UGX 1,680,000 is lost whatever you charge. Orders taken for the quiet weeks, at any price above the variable cost of UGX 143,000 a desk, cover part of it.
Power: plan machine work for grid hours
Where power cuts are frequent, the generator becomes a cost of its own. Plan the cutting and planing for the hours the grid is on, and keep hand work for the rest.
Waste: count rejects by cause
Desks reworked or scrapped at finishing cost labour and materials twice. Waste above the normal level stays out of the product's cost. Paragraph 13.13 makes "abnormal amounts of wasted materials, labour or other production costs" an expense.
Measuring scrap and yield, and fixing the main causes, is the subject of how to reduce manufacturing waste.
How to track manufacturing costs in ArmPOS
ArmPOS has no production module: no bill of materials, no work orders and no automatic use of materials when goods are made. A small maker can still record what each run uses and makes, and work out costs from the reports.
- Set up materials and finished goods as products. Put them in categories such as Raw materials and Finished goods, each with its unit (Add your first products).
- Receive materials with a purchase. The status received adds the stock to the warehouse you choose. The pencil on a line sets its Product Cost: enter the landed cost (Record a purchase).
- Record each run with two adjustments. A Subtraction takes off the materials used, and an Addition puts on the finished goods made. Put the run in the Note, such as "Run 14, 50 desks" (Count and adjust stock).
- Record wages and overheads as expenses. Make categories such as Wages, Rent, and Power and fuel, and record each payment against the workshop's warehouse. Reports › Expense Report totals them by category (Record an expense, on plans with Accounting).
- Set the finished product's cost from the run. The Stock Adjustment Report shows each adjustment's cost. Divide the run's material cost by the desks it made, and enter the result as the desk's Product Cost (Stock reports).
The run method is the one set out in barcodes in manufacturing. It works the same in each of ArmPOS's countries, from Uganda to South Africa.
Keep the full cost, with labour and overhead on normal capacity, in your costing sheet for pricing. Leave labour and overhead out of the Product Cost if you record them as expenses. Profit and Loss takes off both the cost of products sold and the expenses, so they would count twice.
For the year-end accounts, IFRS for SMEs counts labour and production overheads in the cost of desks still in stock. Give your accountant the costing sheet, so the books carry them.
Frequently asked questions
What are the three types of manufacturing costs?
Direct materials, direct labour and manufacturing overhead. Prime cost is the first two together; conversion cost is labour plus overhead.
Is labour a manufacturing cost?
Direct labour is: the pay of the people who make the product. A supervisor's pay is part of overhead, and the pay of office and sales staff is an expense of the period.
Are manufacturing costs fixed or variable?
Both. Materials, piece-rate pay and indirect materials rise with output. Rent, salaried supervision and depreciation stay the same, so the cost per unit moves with volume.
How do you calculate manufacturing overhead per unit?
Add the variable overhead per unit to the fixed overhead divided by normal output. In the example: UGX 7,000 + (4,200,000 ÷ 200) = UGX 28,000 a desk.
What is the difference between manufacturing costs and cost of goods sold?
Manufacturing costs are everything spent making goods in a period. Cost of goods sold is the cost of the goods sold in it, so goods still in stock carry their costs until they sell.
Cost your best-selling product this week, line by line, and check its overhead against a normal month. To keep materials, runs and expenses in one record, create a free ArmPOS account and add your first material as a product.
