A guide to basic accounting for manufacturing businesses

Lean manufacturing is all about minimizing waste while maximizing productivity. It is a practice first initiated by Toyota but has influenced manufacturing for decades, particularly the automobile industry. Since then, many other industries have come to regard removing waste from their processes as beneficial to the bottom line.

As you streamline manufacturing processes to eliminate waste and shorten the time between receiving and orders, you can also streamline your accounting processes and use them to gather relevant operating information. This provides valuable feedback on your manufacturing and inventory processes.

Without adapting accounting for manufacturing processes, especially as it increases in complexity as your business grows, it may be difficult to understand how changes in your operations are making a difference to your manufactring bottom line.

To reduce the costs of doing business, you must understand first where your production costs lie.

It helps if you break down product costs from all the contributing factors that play a part in the cost of the manufacturing product – not only for each item but for all the activities that add cost to the end product.

If you want to refine your production process and automate aspects of your business, accurate costing information helps you identify wasteful costs passed on to the customer or absorbed within the company. This is all in aid of increasing your revenue and your profit margins.

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You need to think beyond profit and loss to manufacturing costs such as the costs of materials, plus the cost to convert these materials into products. This is necessary, for example, to understand how you should be pricing your product and how to achieve or exceed your set profit margins.

In a manufacturing business, there are some important terms you need to understand when it comes to calculating the costs of manufacturing your product, as well as the amount of inventory you hold.

Direct materials

Direct material (or raw material) inventory is a calculation of all the materials your manufacturing business is using to make your product – all the materials consumed or identified with your product.

Very often, this is listed in a bill of materials, which itemizes quantities and costs the materials used in your product. In process manufacturing, such as food and beverage or chemicals, the bill of materials is known as a production recipe.

Direct labor costs

Direct labor is the value given to the labor that produces your goods, such as machine or assembly line operators. Generally, this includes the cost of the regular hours, overtime, and relevant payroll taxes.

Manufacturing overheads

Along with direct materials and direct labor, you must include the cost of manufacturing overhead to ensure you get the right valuation when it comes to inventory and selling price.

Manufacturing overheads might include the costs for powering a factory’s equipment and personnel not directly involved in producing the product.

Work-in-process goods

As part of the manufacturing process, your business is likely to have items in production that have not yet been completed.

This will be an accumulation of the money you have spent on direct materials, direct labor costs,

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