Ever wondered why your product costs more to make than just the price of materials and labor? That extra expense often hides in your manufacturing overhead—a crucial, but sometimes puzzling, part of production costs.
Knowing how to find total manufacturing overhead helps you set accurate prices, control budgets, and boost profits. In this article, we’ll break down what counts as overhead and guide you through straightforward steps to calculate it, so you can take control of your business’s bottom line.
How to Find Total Manufacturing Overhead: A Comprehensive Guide
Manufacturing overhead is a crucial concept in understanding the true cost of producing goods. If you want a clear picture of where your money goes on the production floor, knowing how to calculate total manufacturing overhead is essential. Let’s break down what manufacturing overhead is, how you can calculate it, and the best practices to keep overhead manageable.
What is Manufacturing Overhead?
Manufacturing overhead, often called “factory overhead” or “indirect production costs,” includes all the indirect costs needed to produce goods. These costs cannot be traced directly to specific products the way direct materials or direct labor can.
Key characteristics of manufacturing overhead:
- Indirect expenses related to production.
- Not directly identifiable with a single product.
- Necessary for factory operations.
Common Examples of Manufacturing Overhead
- Factory rent or depreciation on production equipment
- Utilities for the factory (electricity, water, gas)
- Indirect labor (supervisors, maintenance staff, janitors)
- Indirect materials (lubricants, cleaning supplies)
- Property taxes, factory insurance, and equipment repairs
Why is Manufacturing Overhead Important?
Understanding manufacturing overhead is vital for several reasons:
- Product Pricing: Overhead helps set the right price for products.
- Profitability Analysis: Knowing your overhead lets you see which products or departments are most profitable.
- Budgeting: Accurate overhead calculations help with more precise budgeting and forecasting.
- Reporting: It’s essential for financial statements and compliance.
How to Calculate Total Manufacturing Overhead
Let’s walk step by step through calculating total manufacturing overhead for an accounting period.
Step 1: List All Indirect Costs
Begin by identifying every cost that supports production but doesn’t attach to a specific product.
Categories to include:
- Indirect labor (wages of supervisors, maintenance)
- Indirect materials (small tools, lubricants)
- Utilities (factory electricity, water)
- Depreciation on factory equipment
- Factory rent and insurance
- Factory supplies and repairs
Step 2: Separate Direct and Indirect Costs
Be careful not to confuse direct costs—like raw materials and production-line workers’ wages—with overhead.
- Direct: Canvas, thread, and seamstress wages for handbag manufacturing
- Indirect: Factory security, equipment repairs, cleaning supplies
Step 3: Collect Cost Data
Gather expense reports, invoices, payroll records, and financial statements for the period you want to measure (usually a month or year).
Step 4: Add Indirect Costs Together
Simply total all the indirect costs you’ve identified for the period.
Example Calculation:
| Overhead Item | Amount ($) |
|---|---|
| Indirect labor | $10,000 |
| Utilities | $5,000 |
| Equipment depreciation | $3,000 |
| Factory rent | $4,000 |
| Cleaning supplies | $500 |
| Insurance | $1,000 |
| Total Overhead | $23,500 |
Step 5: Apply the Formula
The general formula for total manufacturing overhead is simple:
Total Manufacturing Overhead = Sum of all indirect production costs
Or,
Manufacturing Overhead = Indirect Labor + Indirect Materials + Utilities + Depreciation + Rent + Insurance + Miscellaneous Indirect Costs
Detailed Example: Calculating Manufacturing Overhead
Let’s walk through a practical example using a fictional furniture manufacturer.
- Identify Costs for One Month:
- Factory supervisor salaries: $8,000
- Factory rent: $6,000
- Utilities: $2,000
- Depreciation of machines: $2,500
- Machine maintenance: $1,200
- Factory insurance: $800
-
Indirect materials (lubricants, glue): $400
-
Add the Costs:
- $8,000 (Indirect labor)
- $6,000 (Rent)
- $2,000 (Utilities)
- $2,500 (Depreciation)
- $1,200 (Maintenance)
- $800 (Insurance)
- $400 (Indirect materials)
Total Manufacturing Overhead = $20,900
Components of Manufacturing Overhead
To further clarify, overhead is divided into several key categories:
Indirect Labor
- Supervisors
- Quality inspectors
- Maintenance staff
- Security personnel
Indirect Materials
- Cleaning supplies
- Glue, nails, lubricants
- Replacement parts for machines
Factory Expenses
- Utilities (water, electricity, gas)
- Depreciation of equipment
- Insurance premiums
- Rent or property taxes
- Repairs and maintenance
- Safety equipment
Benefits of Calculating Manufacturing Overhead Accurately
Knowing your overhead offers several important advantages:
- Better Cost Control: See where money is going and spot areas to reduce waste.
- Smarter Pricing: Price products wisely to cover all expenses and ensure profit.
- Improved Budgeting: Accurate numbers help plan for the future with confidence.
- Enhanced Financial Reporting: Meeting accounting standards becomes easier.
Challenges When Calculating Manufacturing Overhead
Several potential obstacles can make manufacturing overhead tricky:
- Identifying All Costs: Some expenses are hard to classify as overhead or direct.
- Changing Costs: Overhead isn’t always steady—it can fluctuate with production volumes.
- Allocation Decisions: Choosing a fair method to spread overhead over products requires judgment and consistency.
Practical Tips and Best Practices
You can make the process smoother and more useful by following some proven tips:
1. Set Clear Definitions
Establish company guidelines differentiating direct from indirect costs.
2. Choose a Consistent Allocation Method
Select a fair way to allocate overhead, such as:
- Direct labor hours: Spread overhead based on hours worked.
- Machine hours: Use machine operating time.
- Units produced: Divide by the number of items made.
3. Review Overhead Regularly
Periodically check and update your list of overhead costs. Business needs change and new costs arise.
4. Use Technology
Accounting software helps categorize, track, and report overhead costs efficiently.
5. Compare Overhead to Industry Benchmarks
See how your overhead lines up with similar businesses. High overhead may mean room for efficiency gains.
6. Include All Hidden Costs
Don’t overlook small expenses—they add up over time!
How to Reduce Manufacturing Overhead
Lowering your overhead can boost efficiency and profits.
- Automate repetitive tasks: This reduces indirect labor costs.
- Increase energy efficiency: Upgrade equipment or change factory habits to lower utility bills.
- Negotiate better leases: Work to lower rent or identify cheaper properties.
- Outsource non-core activities: Consider contracting out cleaning, security, or maintenance.
- Regular maintenance: Prevent expensive repairs or unplanned downtime.
Frequently Asked Questions (FAQs)
What is included in manufacturing overhead?
Manufacturing overhead covers all indirect costs involved in producing goods. Typical items include factory utilities, indirect labor (like supervisors), equipment depreciation, maintenance, factory rent, insurance, and indirect materials (like cleaning supplies).
How is manufacturing overhead different from direct costs?
Direct costs (like raw materials and worker wages) can be traced to specific products. Overhead costs, on the other hand, are shared by all products and cannot be linked to just one item. They support the production process as a whole.
Why is it important to calculate manufacturing overhead?
Accurately calculating overhead ensures you understand your business’s true production costs. It informs product pricing, budgeting, profitability analysis, and financial reporting, helping managers make better decisions.
What is an overhead rate, and how is it calculated?
An overhead rate is used to allocate overhead costs to each unit produced, based on a specific driver (like labor or machine hours). It’s calculated as:
Overhead Rate = Total Manufacturing Overhead / Total Allocation Base (e.g., total labor hours)
Applying the rate helps assign a fair share of overhead to each product.
Can manufacturing overhead costs be reduced?
Yes! You can reduce overhead by automating processes, cutting utility usage, reviewing and negotiating contracts, outsourcing certain activities, and carrying out regular equipment maintenance to prevent costly breakdowns.
Conclusion
Finding your total manufacturing overhead doesn’t have to be overwhelming. By understanding which costs qualify as overhead, methodically gathering data, and applying a simple formula, you’ll gain clear visibility of your manufacturing expenses. This clarity helps you price products effectively, plan for growth, and keep your operations profitable. With some diligence and smart management, you can even trim overhead and improve your business’s bottom line.
Ready to get started? List those indirect costs, total them up, and watch your business insight grow.
