Calculating factory overhead is an important part of managing a company’s manufacturing operations. Knowing what factory overhead includes can make the entire manufacturing process more efficient and help you track any indirect costs associated with manufacturing your products. Understanding the most important items included in factory overhead can be an essential piece of information when growing and developing a business.
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In this article, we discuss what factory overhead includes and describe how to calculate some of its most often common elements.
What is factory overhead?
Factory overhead represents the costs incurred by an organization when manufacturing a product, except the costs of direct labor and materials. Also called manufacturing overhead, it comprises these major parts:
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Indirect labor: This refers to all the costs for employees not directly involved in the manufacturing of a product. It includes all employees that are crucial for the organization’s well-being but don’t assist in the creation or delivery of products, such as supervisors, inspectors, janitors, maintenance workers, drivers, repairmen, warehouse handlers and other similar roles.
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Indirect materials: This refers to all materials used throughout the manufacturing process but not when actually manufacturing products. They mainly comprise various consumables that are used for multiple tasks and processes, like lubricants, cleaning products, protective gear, tape, glue and other similar items.
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Costs related to the factory: The costs required to keep the factory operating are also part of the factory overhead. They comprise fixed costs like rent, insurance, utilities, maintenance, depreciation and others that aren’t directly linked to production and variable costs like the ones for indirect materials and utilities that vary according to the number of units produced.
What does factory overhead include?
Seven of the most often encountered factory overhead costs are:
1. Factory rent
Rent is the cost that a business needs to pay for using various business facilities, such as office and factory space. The company’s management pays it to the owners of the premises based on a signed contract up to a predetermined date.
Rent costs are usually a significant part of an organization’s overhead which businesses pay on a monthly, quarterly or annual basis. If a company decides to buy the factory, the losses caused by depreciation, if any, are part of the factory overhead.
Example: An organization pays $4,500 per month for renting their factory floor and another $3,000 per month for their office space. Their total expenses with rent are part of their overhead, but only the $4,500 per month paid for their factory is part of factory overhead.
2. Factory utilities
The cost of utilities required to run a factory, such as water, electricity, internet, gas and others are also part of a factory’s overhead. Businesses can sometimes reduce these costs by negotiating with multiple suppliers or committing to a long-term deal.
Example: A company pays $860 per month for water at their factory, $5,000 for electricity, $500 for internet and $150 for sewage. Their total factory overhead costs related to their utilities are $6,510 per month.
3. Factory machinery and vehicle maintenance
Members of many organizations regularly inspect and maintain all tools and equipment inside a factory. They also repair them whenever they stop functioning properly, to ensure normal production parameters. You can consider all costs associated with keeping factory machinery operating optimally as factory overhead costs.
Example: When assessing the total business costs for the calendar year 2020, a company calculated that they spent $13,000 for regular equipment and vehicle maintenance and a total of $27,000 for repairing faulty equipment and vehicles. Their machinery maintenance costs are part of their factory overhead and amount to $40,000 per year.
4. Factory insurance costs
While total insurance costs are part of a company’s overhead, the insurance costs solely related to the factory are part of its factory overhead. These costs can include insurance fees for the factory building, various pieces of equipment, employee health and safety, vehicles and any other insured factory item.
Example: An organization pays $23,000 per year for insuring their factory, $33,000 for equipment insurance and $20,000 in liability insurance for its factory workers. The total amount of factory insurance costs is part of the factory overhead and is $76,000 per year.
5. Factory supervisor and maintenance staff
Factories often require supervisors and inspectors to regularly check and make sure their team meets all production procedures and ensures that all manufactured products are up to certain standards.
They also require employees who perform regular maintenance operations to ensure that all used equipment is functioning properly and is delivering the expected output. Because they work in a factory but their work doesn’t directly relate to a single product, the cost for these employees is part of the organization’s factory overhead.
Example: An organization employs three factory supervisors tasked with making sure every employee performs their job according to predetermined standards, at a cost of $50,000 per year for each supervisor. It also employs an inspector that checks the final products for production flaws for a cost of $45,000 per year and four maintenance workers that work to keep all equipment running optimally for a cost of $38,000 per year for each worker. Their total staff-related factory overhead cost is $347,000.
6. Factory supplies
Besides the materials directly used to manufacture a product, factories also require other supplies to keep production running as usual. They’re usually items that employees use or various pieces of machinery required to function at optimal parameters.
Example: An organization pays $2,300 per year for their factory employees’ uniforms and helmets, $8,500 per year for machinery lubricant designed to keep machines running well and prevent degradation, $2,000 per year for cleaning products and equipment and an additional $1,000 per year for other required consumables that aren’t directly involved in the manufacturing process. Their factory overhead costs related to factory supplies are $13,800.
7. Factory management
The employees who manage the factory and constantly make decisions regarding various aspects of everyday operations are also part of the factory overhead costs, as they’re crucial for the factory’s efficiency but not directly involved in product manufacturing.
Example: A company employs a factory manager, for a total cost of $78,000 per year. The factory comprises three separate production floors, each with its own floor manager. The total yearly costs for each floor manager are $50,000. Therefore, the total factory overhead costs related to the factory’s management amounts to $228,000.
I hope you find this article helpful.
