Cost of Production: Key Factors Explained 

For many manufacturering  businesses, the cost of production is among the most crucial figures of the business. It has a direct influence on pricing, profitability and competitiveness in the long run. But in most SMEs, an estimate of cost of production or spreadsheet or after the event accounting report is used- often many weeks after the damage is done.  

This blog will describe the major aspects of cost of production, the reasons why companies have difficulty controlling them, and how an ERP system such as Synergix ERP Software can enable businesses to compute, monitor, and manage the costs of production.  

Cost of Production Definition and Key Factors 

Production costs are the combined total of the costs necessary to transform the raw materials into marketable products, and they are divided into direct costs (materials and labour that can be directly linked to products) and indirect costs (utilities, depreciation and administration). Overlooking these costs may run margins down within a short time; an example of this is the fluctuating input prices which tend to push the total costs on the operating expenses.  

 [ Inforgraphic : key factors]  

Raw Materials 

Cost of expenses decided by the raw materials, which are influenced by the suppliers and international supply chains, as well as the quality requirements. This volatility is magnified by the commodity price spikes, including geopolitical spikes. To reduce holding costs and wastage, businesses avoid risks by diversifying their suppliers and having real-time inventory updates.  

The inventory management module of Synergix ERP uses the demand forecasting to optimise procurement thereby minimising surplus stock. Key strategies include:  

1. Contracting long term agreements on price stability.  
2. Adopting quality assurance to reduce scrap rates.  
3. Using ERP analytics feature to have a deep insight on suppliers’s performance.  

 Labour  

The labour expenses include wages, benefits, training, and overtime, which is especially a heavy load on the labour-intensive industries such as textiles or assembly. These are swelled up by inefficiencies like skill mismatch or inefficient rostering that creates idle time or mistakes. Skills mapping and flexible scheduling are required to manage it effectively.  

ERP Software handles this through workforce planning applications that match the ability of the staff to the production requirements that will help to prevent overtime. Practical steps may involve but not limited to: 

1. Time-and-motion studies to come up with baselines.  
2.  Implementing compensatory bonuses that are output-oriented.  
3. Optimisation of shifts with the help of ERP dashboards.  

Explore : Production Management Software for Manufacturing SMEs   

Overhead Costs 

Every overhead cost such as energy, maintenance, rent, compliance costs tends to creep in the background, but they compound due to the inefficiencies such as the machine down time. The energy used in any given process differs- heavy industry uses much energy- hence the need to monitor it as utility tariffs in the country increase. Predictive maintenance eliminates unplanned failures that cause stagnation.  

To simplify the reporting process, many companies have been putting overhead in the same product. This method is not very real-world, although it is convenient, particularly in the presence of varied product lines or customised orders. Complex products might be much more resource consuming but seem artificially profitable. 

Modern ERP supports overhead allocation based on logical cost drivers such as machine hours, labor hours, or production volume. This results in a more accurate and defensible cost of production, particularly important for management reporting and pricing decisions.  

The costs of logistics include the cost of sourcing inbound, the costs of handling internally and the costs of distribution to the final demand which is enhanced by delays or poor route choices. Demurrage or packaging mistakes are only a few examples of hidden expenses that accumulate very quickly. These are countered with the help of holistic supply chain visibility. To allow optimisation of routes and prevention of stockout, ERP software can track your business from procurement to delivery.    

Hidden Costs

Numerous companies do not accurately predict the cost of production since some of them are concealed. Standard cost computation usually does not take into account rework, rejects, machine downtime, yield loss and urgent procurement, although at times the total effect of these can be significant.  

Less visibility of production is also one the major factors that lead to the margin erosion among manufacturing SMEs. A recent study by Deloitte points out that it is there’s a big trend called “Agile Manufacturing”, which is about adopting a digital infrastructure that makes near real-time data on data available, rather than lagging monthly or quarterly sales reports. These are the losses that are usually passed as inevitable, and not be controlled without any dependable data.  

The production exceptions and non-productive time are normal operations of Synergix ERP. By identifying these costs and making them visible and measurable, businesses are able to focus on corrective measures including preventive maintenance, process redesign or better planning of production.  

Do not miss out: What are the Objectives of Production Planning and Control?

Cost of Production Measurement  

The genuine difficulty of manufacturing and operations-based enterprises to quantify cost of production is becoming a recurrent problem especially with the rise in product differentiation, customisation of orders, as well as fluctuation in the cost. Cost of production in principle is calculated as a combination of direct material cost, direct labor cost and manufacturing overhead. Practically, this is hard because it is necessary to capture such costs at the appropriate level of detail and connect them with real production activity instead of using averages or assumptions. When cost of production is calculated too broadly, as it is at monthly or plant level, critical distinctions in products, batches or jobs are lost and, therefore, distorted analysis of profitability results. 

An effective method of measurement will necessitate cost of production to be computed at the same level as commercial and operating decisions are made. In the case of standardised and high volume products, batch-level costing can be adequate. Nevertheless, in the case of customised, low-volume or project-based manufacturing, job-level costing would be much more accurate. An example is when two orders need very different processing time, quality control or finishing due to the use of similar materials. When the two are priced under the same standard assumptions, the more complicated order will be considered more profitable than it was actually, and the simple orders will silently bear the loss.  

Limitations of Spreadsheet-Based Cost Management 

Cost of production analysis is still popular when it comes to spreadsheets, and small organisations are no exception. Nevertheless, the spreadsheet-based techniques are over-reliant on manual data and past results, which add to the probability of mistakes and accessibility delays.  

These restrictions increase as the volumes of transactions increase. Information on costs is not provided to managers in time to take any action and it becomes even harder to trace the variances to their original causes. With an ERP system, the production, inventory, and financial information is centralized, and cost of production information is available on time, at regular intervals and is auditable.

Cost of Production: How to Reduce

How To Reduce the Cost of Production?

Making the production process more cost-effective does not mean spending less money, but is a matter of better utilizing resources throughout the production. Most cost cutting efforts fail due to their short term oriented nature, i.e. cutting labor or maintenance expenses, without eliminating the factors that cause inefficiency. This method usually leads to a higher amount of rework or downtime or reduced quality of products and eventually it causes the production costs to go back up. 

Reduction in sustainable cost of production is done through identification and removal of waste in materials, labor and overhead. Some of the ways through which material expenses can be cut include; the enhancement of yield, the management of scrap and the synchronization of procurement to current production demand. Instead of just cutting down on the number of employees, labor costs can be dealt with through enhancing productivity, workload, and restructuring processes that are not productive. The overhead costs need to have a clearer picture into the consumption of machine time, energy and support activities, to rectify the underutilised capacity and bottlenecks. A study conducted by McKinsey reveals that predictive maintenance shortens the machine downtime by 30 to 50 percent and extends the life of a machine by 20 to 40 percent, which leads to a decrease the cost of production. 

How ERP Help to Reduce Production Cost. 

ERP software assists in the minimisation of production costs by adding order and visibility to all sectors where the weaknesses tend to concentrate without the realisation of the organisation. In the majority of manufacturing settings, there is seldom a single problem that leads to the high production costs. They tend to stem more frequently out of minor, repetitive issues in the procurement, inventory, production and cost allocation. 

Synergix Manufacturing ERP Software lowers the cost of production in several fundamental ways: 

• Adjusting the material planning and the real production demand, which allows avoiding over-purchasing, and surplus production. 
• Actual material consumption and production output are recorded rather than making standard assumptions. 
• Making the productivity gaps visible by associating labor time with jobs or production orders. 
• The amount of materials used is captured per production order, hence accurate unit costing is possible. 
• Different processes are associated with labor hours to detect inefficiencies at an early stage. 
• Machine hours, labor hours, or production volume are all counted in the overhead costs. 

[Inforgraphic] 

And, most importantly, Synergix ERP assists in managing real-time cost control. Variance reports, operational dashboards enable the managers to identify abnormal costs as long as production is still taking place and, therefore, corrective action can be taken before margins are influenced. 

Essential Takeaways 

The cost of production needs to be considered as a disciplined operation and not a fixed accounting number. The companies, which know their cost structure well, are better placed to price competitively, defend margins and grow with confidence. 

Cost of production is an active management tool which can be used with Synergix ERP Software that helps in better decision-making. The result is that it will have a better cost control, better profitability and more sustainable growth in the ever more competitive manufacturing environment.

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