Knowing what manufacturing overheads and its costs are will help you manage your business better. Here's more...
Overheads are indirect expenses which need to be considered while managing a factory on a day-to-day basis. The other name given to manufacturing overhead costs are factory costs, which include the money spent by companies in producing goods.
Running a business has become more and more challenging these days due to increased competition and rising start-up costs. Raw material costs have shot up, and firms with improper management may have a tough time maintaining their profit margins or even staying afloat.
In other words, it is also described as a factory burden. Factory overheads will mainly constitute the cost of plant and machinery, cost of fuel, power expenses, salaries paid to the workers, expenses on lighting purposes, insurance expenses, etc.
For the calculation of the money spent on running the factory, what you require is the total of all the factory overheads and the prime cost. The prime cost is nothing but the sum of the material consumed by the factory, direct wages, and the direct expenses made by the factory owner.
The formula for prime cost is:
Prime Cost = Materials Consumed + Direct Wages + Direct Expenses.
The equation to compute factory cost is:
Factory Cost = Prime Cost + Sum of All Factory Overheads.
Overheads are of two types―fixed overheads and variable overheads. Fixed costs would be the rent payments and the salaries of the workers. They do not change with an increase or decrease in the levels of production. The production output or levels of a company strictly depend on the demand for its products in the market.
When the demand is more, the factory would be utilizing its full capacity and produce maximum goods. When the demand is less, full capacity would not be used to control costs. Fixed costs are the expenses the factory owner has to bear, irrespective of the profits and production made by the factory.
On the other hand, variable costs would be those which increase with the rise in production levels. For example, raw material costs will rise when the number of goods being produced increase, and vice versa.
Manufacturing overhead costs can be used further to calculate the cost of production, total cost, and total sales generated by the company.
When you add office and administration expenses such as manager's salary, salary of the director, stationery expenses for the office, lighting expenses for the office, to the factory cost, you will get the cost of production.
Further, by adding the selling and distribution overheads to the cost of production, which mainly consist of marketing expenses, you will get the total cost for the enterprise. The total sales, finally, would be obtained with the sum of the total cost and the net profit.