When you are calculating your production costs, understanding machine hours and overhead are essential. Understanding your machine hours and the overhead costs per machine hour will help you with product pricing. The terminology may sound complicated if you are not familiar with it, but the actual calculations are easier than you might think.
Manufacturing Overhead Costs
Manufacturing overhead is the term used to describe the costs directly associated with supporting your production operations. These are expenses that you pay only because of the product manufacturing. Some of the costs included in manufacturing overhead include the depreciation of your manufacturing equipment and warehouse, the utilities for that building and the salaries of your factory supervisors. Do not include the cost of your actual factory production staff. Those costs are direct labor costs and do not apply to your overhead. The overhead costs are specifically the costs associated with keeping the factory running and operational.
Machine Hour Calculation
The time that a machine spends in active operation is referred to as machine hours. If you operate your production floor in two eight-hour shifts every day and your equipment runs continuously, your equipment logs 16 machine hours a day. On a five-day work week, that's 80 hours a week, which comes out to 4,160 machine hours per year for each machine.
Putting it Together
Before you can price your products appropriately, you need to know exactly what it costs you to make it. This calculation is dependent on both the overhead costs and your machine hours. Once you know your machine hours, you can determine how much it costs you per machine hour to operate your facility. For example, if your facility logs 6.933.4 machine hours every month with an estimated overhead expense of $18,000 per month, your facility costs $2.59 per machine hour to operate. Determine how many products you produce during the hour, and you can distribute that cost per unit to ensure that you recover your overhead costs as part of your pricing. For example, if you produce 100 units per hour, you will add an additional $0.26 to each product’s retail price to offset your overhead costs.
Tara Kimball is a former accounting professional with more than 10 years of experience in corporate finance and small business accounting. She has also worked in desktop support and network management. Her articles have appeared in various online publications.