Benefits of standard costing method for production
Manufacturing companies strive to reduce their production costs to stay competitive. Their margins are constantly challenged by others. Improving their operational efficiency is a proven way of staying relevant in the market. To achieve their goals, manufacturing companies need to set their standards, track actuals, determine variances and work towards minimizing them. Their business applications can help them in their journey through standard costing.
Everything we see around us is manufactured by a company. That company had to calculate the cost of the product ignorer to come up with its sales price. This cost is generally composed of three components, namely material, labor, and overhead. Each cost component can be estimated upfront. These estimations can be captured in your business application to roll up to a final number that sets the standard cost of the manufactured product. Let’s dive into each of these components.
Material cost can be calculated through a Bill of Materials (BOM) roll-up. BOMs maintain the quantities and scrap ratios of components and raw materials that make the product. Labor cost can be calculated through a Route/operation roll-up. They maintain the setup, run, queue, etc. labor times that go into making the product. Finally, overhead is the remaining indirect cost that can be tied to either material or labor costs. They capture many material handling, depreciation, utilities, quality control, etc. Standard cost sets the base for how much direct material and direct labor are needed to manufacture the product including the associated indirect costs.
Once you setup your standards, you can start tracking your actuals. This requires data collection from the manufacturing execution level. You can take small steps. For example, you can track your most expensive material consumption. Operations can record their actuals against the production orders as they are consuming the material. For labor, you can follow the same logic. You can record time against the high-cost operation. For more accurate tracking, you can collect operational time data directly from machines. Since collecting accurate and timely information may be challenging from the manufacturing follow, you can gradually introduce material and labor tracking methods into your operation.
The results can be quite eye-opening. Once you have standards and then gradually better actuals, you can start identifying variances. Since data is captured at the product order level, variances can be associated with the date, time, operator, machine, finished goods, raw material lot #, etc. You can analyze this data to identify patterns. You can determine what is causing the variance such as an untrained operator, bad raw material lot, malfunctioning machine, time of the operation, etc.
During new system deployments, make sure to migrate good BOM and route/operation data. Take the time to do cost roll-ups after the data migration to check with your current costs. Resolve the discrepancies. Have a plan to introduce actual material and labor tracking in your operations. Have the end game in mind. Be prepared to analyze the variances. Decide on how you would take action from those insights. If you do these things right, you will get into a continuous improvement loop and keep your costs under control
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My name is Cem and this has been another gem.
