Understanding Total Product Cost for Integrated Products
Many companies that sell fully integrated products – including manufacturing, assembly, warehousing, and shipping – often under-record their total cost of sales. This can lead to incorrect product pricing, ultimately reducing valuable operating profits.
It’s well known that inventory cost is also considered the product cost in gross margin calculations. However, what may not be as commonly recognized is the importance of including all costs associated with the manufacturing and assembly processes.
As experts in helping manufacturing organizations optimize their financial processes, we’ve outlined a breakdown of expected costs, commonly overlooked expenses, and tips to ensure accurate product costing.
Expected Costs:
- Labor
- Materials
- Overhead
Commonly Overlooked Labor Costs and Situations:
- Labor availability: A limited labor pool leads to higher costs and increased turnover.
- Labor turnover: Training new staff increases processing time and scrap rates.
- Labor cost differentiation: Separating regular wages, overtime, and labor earned helps evaluate the absorption rate.
- Consumables: Items such as glue, water, grease, and other materials not classified as raw materials.
- Building costs: Rent, utilities, maintenance, and insurance should be factored in.
- Property and real estate taxes: Inventory levels and storage locations can significantly impact tax obligations.
- Equipment costs: Rental fees, repairs, parts, and supplies add up over time.
- Depreciation on manufacturing/assembly assets: Depreciation should be accounted for in cost calculations.
- Purchase Price Variance (PPV): Accounting for PPV can provide a clearer picture of complex manufacturing and assembly processes.
Regular Reviews: How to Ensure Accurate Product Costing
To ensure the correct costs are included in product pricing, regular reviews of the following areas are essential.
Raw Materials & Components – Landed Cost
Landed costs (including purchase cost, freight, and duty fees) can fluctuate due to factors like Minimum Order Quantity (MOQ) and lead time changes, which impact freight costs. Conducting frequent reviews of landed costs ensure inventory is properly valued. Standard costing can help absorb cost variations, leading to a more balanced approach to inventory pricing.
Bill of Materials (BoM) Setup – Substitutions & Components
If product design and marketing teams approve material substitutions, but these changes are not communicated to BoM builders, financial discrepancies may arise. This can lead to increased scrap costs or additional advertising expenses to realign with marketed product expectations.
Assembly Builds – Time Studies & Cost Adjustments
Labor costs in assembly vary significantly and should be closely monitored. Regular time studies help maintain accurate absorption rates. High turnover rates can also impact build times and scrap rates, as skilled workers are generally more efficient than trainees.
If material sources change frequently, the standard cost should be updated accordingly or set at an average cost.
PPV and Labor Earned Accounts – Analyzing Actual vs. Standard Costs
PPV accounts should be reviewed at least quarterly to track expenses such as freight-in, duty, consumables, and standardized packaging. Additionally, the Labor Earned metric should be monitored monthly to assess factory floor efficiency and determine whether labor rates need to be adjusted due to wage increases.
Final Thoughts on Understanding Total Product Cost for Integrated Products
Reducing costs will improve margins, but the key to sustained profitability lies in understanding the total product cost. Accurately pricing products based on comprehensive cost analysis ensures a company maintains a healthy margin while remaining competitive in the market.
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