How much does it cost?

Put a finished bearing housing on the table and ask what it cost to make. In a manufacturing business, you might get three different answers. One person gives you the material and machining cost. Another adds painting and inspection. Someone else tells you what you sold it for. All three figures might be useful, but only one question was asked.

Start with what you expect to spend

When I build a costing model, I start with next year’s cost budget and a realistic estimate of the production hours we expect to book to jobs. What will it cost to run the business for the year, and how many hours of production will carry those costs? The sales budget has its place, but it can’t tell you what an hour of production costs.

The hours need as much scrutiny as the pounds. Start with available time and allow for holidays, maintenance, training and other time that won’t be booked to jobs. Be clear about where setup, inspection and rework go. If they belong to a job, capture them against it. If they sit in overhead, account for them there. Either way, the hours need to show up somewhere.

Dividing the annual cost to be recovered through production hours by those planned hours gives you an average cost per hour across the business. Keep separately charged items such as direct materials out of that calculation so you don’t count them twice. The average is a useful check on the whole model. A paintbench and a million-pound multi-axis machine tool, though, are very different places to spend an hour.

Build the rate in three parts

I like to see labour, overhead and the capital cost of the work centre separately. You can start with a common labour rate and a common overhead rate across work centres, then refine those assumptions if there is a good reason. Labour covers the people doing the work. Overhead covers the shared costs of running the business. The capital element reflects the equipment the work centre uses. Keep any capital cost you charge separately out of the shared overhead pot.

Take that million-pound machine. If, for planning purposes, you expect to use it for ten years and book 2,000 machine hours a year, you have 20,000 hours over which to recover the investment. Ignoring any residual value, that puts £50 an hour into the rate for the machine itself, before labour and shared overhead. If it only does 1,500 hours, the original £50 rate recovers £75,000 that year against the £100,000 planned. The machine still cost what it cost.

The market has a say in the selling price

Suppose your starting labour and overhead rate is £120 an hour, before the capital element, but you can only sell painting at an effective £50 an hour. Changing £120 to £50 on the quote doesn’t save £70. If the cost budget stands, the rest of the work has to make up the shortfall. You may be able to recover more overhead through machining or another operation where the market supports it.

I’d keep that commercial decision visible in the calculator. If you shift some overhead recovery away from painting, check that you’ve put the same amount back elsewhere, using the planned hours at each work centre. An extra £10 an hour on a centre with 500 hours does very little to cover a £70 gap on 1,000 hours of painting. And if the other work can’t carry the shortfall at achievable prices and volumes, you have a decision about the work you take on or the costs you need to change.

What did we actually recover?

This is the part I want the board and the management team to understand. If we book fewer productive hours than planned, we spread our fixed costs over fewer hours. A workshop can look busy while falling short of the hours needed to recover those costs. Recording the time properly lets you see the difference between an empty order book, downtime and jobs that take longer than you allowed for.

I’d review it during the year. Look at the hours booked, what the work actually recovered and what the business actually spent. Over the full year, if sales cover all actual costs, you’ve broken even. Recovering more overhead than budgeted can help you beat your profit plan. The final result also depends on the prices you achieved, the mix of work and what you spent.

When someone puts that bearing housing on the table, I want us to be able to answer two questions with confidence. What did it cost us to make, and did the price we achieved do its share of paying for the business?