Estimating the production cost is a process to identify and measure the production expenses for one year and to project these costs for (5-10) years. It includes direct (e.g., raw materials and labour) and indirect expenses (e.g., depreciation and other production overheads). The importance of estimating the production cost shows the product costs, controls costs, makes pricing and business decisions, and enables profitability planning and measurement.
Step-By-Step Process
- Review the production program and production fixed assets (e.g., machinery and building) to identify products, and estimate direct and indirect production costs.
- List and estimate all production expenses yearly (e.g., consumed raw materials, staff costs, utilities, maintenance, production depreciation, factory supplies, etc).
- Estimate the cost of materials: Create a detailed list of all the components, materials, and subassemblies required to manufacture the product, including quantities, specifications, and unit costs for each item.
- Estimate the cost of staff: Determine the labour requirements for manufacturing the product. This includes identifying the number of workers needed, their skill levels, and the time required for each task. Calculate the labour cost based on wages, benefits, and overhead expenses.
- Allocate indirect costs to products: Identify and allocate indirect costs associated with manufacturing, such as factory rent, utilities, equipment maintenance, and other overhead expenses. Allocate these costs based on factors like machine hours, labour hours, or square footage.
- Estimate the depreciation costs: Consider the cost of machinery, equipment, tools, building and other fixed assets needed for production. This includes purchase or lease costs, installation, maintenance, repairs, and depreciation. Calculate the cost per unit based on the expected lifespan and production volume.
- Estimate the cost of waste by considering a percentage of direct cost (e.g., 1-3%).
- Estimate the packaging and shipment costs.
- Allocate a contingency budget (e.g., 3% of production cost) to account for unforeseen expenses, price fluctuations, or other uncertainties that may impact production costs.
- Once you have gathered all the cost estimates as per the above, review and analyse the data by identifying cost drivers, potential areas for cost reduction, and any factors that may significantly affect the overall manufacturing production costs
- There are many ways to estimate the production cost, including estimation of each expense account, estimating the total production cost as a percentage of expected sales for the same year, based on similar experience, checking industry benchmarks or indicators, collecting suppliers’ quotations of raw materials and services, or consult experts.
- As per the above estimates, prepare a table listing the total production costs, segregating them into direct and indirect costs. Also, estimate the production cost of products by estimating the direct and indirect cost of products.
- Prepare the costing document as per the above outcomes, and share it with your team and experts.
Example
Here are the production costs of a pharmaceutical manufacturing facility:
| Sub-accounts | Year 1 ($/Yr.) | Year 2 ($/Yr.) | Year 3 ($/Yr.) |
| Cost of raw materials, packaging and waste | 115,858 | 1,748,879 | 4,507,227 |
| Factory staff costs | 1,193,976 | 3,404,880 | 5,859,132 |
| Utility costs | 7,335 | 110,722 | 285,355 |
| Maintenance costs | 7,384 | 111,465 | 287,270 |
| Communication costs | 1,231 | 18,578 | 47,878 |
| Travelling costs | 1,231 | 18,578 | 47,878 |
| Machine and tool calibration costs | 2,112 | 31,879 | 82,159 |
| Insurance costs | 1,231 | 18,578 | 47,878 |
| Office supply costs | 615 | 9,289 | 23,939 |
| Cleaning costs | 1,231 | 18,578 | 47,878 |
| Safety and fire service costs | 1,231 | 18,578 | 47,878 |
| Staff development costs | 1,231 | 18,578 | 47,878 |
| Factory- Internet and IT services costs | 1,231 | 18,578 | 47,878 |
| Hospitality costs | 615 | 9,289 | 23,939 |
| Factory depreciation cost | 7,266,914 | 7,266,914 | 7,266,914 |
| Royalty cost | – | – | – |
| Factory transportation | 615 | 9,289 | 23,939 |
| Other factory costs | 86,040 | 128,327 | 186,950 |
| Total | 8,690,081 | 12,960,977 | 18,881,973 |
Useful Tips
- Brainstorm the production cost with your team.
- Be aware of the industry benchmarks and indicators about production costs.
- Consult industry experts before you estimate the production costs.
Things To Avoid
- Avoid guessing works and assumptions without evidence.
- Assume fixed prices of raw materials, equipment, utilities, staff salaries and other production cost accounts.
Final Note
This article is sourced from my new book- Your Guide For Preparing An Industrial Feasibility Study.
For more information about the book: https://growenterprise.co.uk/book-your-guide-for-preparing-an-industrial-feasibility-study/
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The author: Munther Al Dawood- Industrial Enterprise Expert
Grow Enterprise 