Production metrics: costs
1
Course organisation
Objective
Planning
Basic production metrics (KPI), strategies for production
CM
system and supply chain management
Production metrics: basics on production costs
ED1
Information flow in supply chain and the information systems:
ED2-3
ERP basics, planning (from tactical to scheduling), MRPII
Production system modeling (Queuing theory, Bottleneck
ED4-5
model, VSM) and decision-making
Decision-making based on Theory of Constraints and
ED6
Simulation
Building descrete event / flow simulation models (in
ED7-10
AnyLogic)
Group project: flow simulation & decision-making
2
ED11-14
Evaluation
Type of
Ponderation of
evaluation the evaluation
Test1: QCM & Short
exercises
Test2: Open
questions &
Excercises
*CM1 & ED1
knowledge is
needed*
Oral
defense
of the
project
Report of
the
project
10%
Individual
40%
Group
35%
15%
Manufacturing
Costs
Manufacturing Costs
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Fixed and Variable Costs
Manufacturing
Costs
Manufacturing costs can be classified into two major categories:
(1) fixed costs (Cf) and
A fixed cost is one that remains constant for any level of production output (the cost of the factory building and
production equipment, insurance, and property taxes).
All of the fixed costs can be expressed as annual amounts. Expenses such as insurance and property taxes occur
naturally as annual costs. Capital investments such as building and equipment can be converted to their equivalent uniform
annual costs using interest rate factors.
(2) variable costs (Cv)
A variable cost is one that varies in proportion to production output. As output increases, variable cost increases (direct
labor, raw materials, and electric power to operate the production equipment).
The ideal concept of variable cost is that it is directly proportional to output level.
Total cost [€/yr] is then:
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Direct Labor, Material and Overhead
Manufacturing
Costs
An alternative classification separates costs into direct labor, material and overhead.
This is often a more convenient way to analyze costs in production.
(1) Direct labor cost
… is the sum of the wages and benefits paid to the workers who operate the production equipment and perform
the processing and assembly tasks.
(2) Material cost
… is the cost of all raw materials used to make a product.
(3) Overhead cost
… are all the other expenses associated with running the manufacturing firm, divided into:
materials
expenses
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a) factory overhead – is a fix cost that consists of the costs of operating the factory other than direct labor and
b) corporate overhead - is the cost not related to the company’s manufacturing activities, such as the corporate
Direct Labor, Material and Overhead
Typical Factory Overhead Expenses
Typical Corporate Overhead Expenses
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Manufacturing
Costs
Direct Labor, Material and Overhead
Breakdown of cost for a manufacturing product
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Manufacturing
Costs
Direct Labor, Material and Overhead
Manufacturing
Costs
How to allocate overhead costs?
The objective is to determine an overhead rate that can be used in the following year to allocate overhead costs
to a process or product as a function of the direct labor costs associated with that process or product.
Separate overhead rates will be developed for factory and corporate overheads.
The factory overhead rate (FOHR) is calculated as the ratio of factory overhead expenses (FOHC) to direct labor
expenses (DLC):
The corporate overhead rate (COHR) is the ratio of corporate overhead expenses (COHC) to direct labor expenses:
Both rates are often express as percentages.
If material cost were used as the allocation basis, then material cost would be used as the denominator in both ratios.
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Cost of Equipment Usage
Manufacturing
Costs
Overhead rates – based on labor cost alone (what if we have different machines?)
To deal with this difficulty, the cost of a worker running a machine can be divided into: direct labor and machine cost.
Each is an applicable overhead rate.
These overhead costs apply not to the entire factory operations, but to individual machines.
The machine annual cost is the initial cost of the machine apportioned over the life of the asset at the appropriate rate of return
used by the firm. This is done using the capital recovery factor, as:
UAC = equivalent uniform annual cost, $/yr; IC = initial cost of the machine and (A/P, i, N) = capital recovery factor that converts
initial cost at year 0 into a series of equivalent uniform annual year-end values, where i = annual interest rate and N = number of
years in the service life of the equipment:
You DON’T need to know
it by heart
The uniform annual cost can be expressed as an hourly rate by dividing the annual cost by the number of annual hours of
equipment use.
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Cost of Equipment Usage
Manufacturing
Costs
The total cost rate for the machine is the sum of labor and machine costs.
This can be summarized for a machine consisting of one worker and one machine as follows:
where Co = hourly rate to operate the machine, $/hr; CL = direct labor wage rate, $/hr; FOHRL = factory overhead
rate for labor; Cm = machine hourly rate, $/hr; and FOHRm = factory overhead rate applicable to the machine.
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Cost of a Manufactured Part
Manufacturing
Costs
The unit cost of a manufactured part or product is the sum of the production cost, material cost, and tooling cost.
The unit production cost for each unit operation in the sequence of operations to produce the part or product is given
by:
Tpi = production time of operation i, min/pc,Cti = cost of any tooling used in operation i, $/pc
The total unit cost of the part is the sum of the costs of all unit operations plus the cost of raw materials:
Cpc – cost per piece, $/pc; Cm - cost of starting material, $/pc; and the summation includes all of the costs of the no
unit operations in the sequence.
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Short examples
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Plant / Production Capacity (PC)
Production
Performance
Metrics
Example: Weekly Production Rate
A small machine shop has two machines and works 40 hr/wk. During a week of interest, four batches of parts
were processed through these machines. Batch quantities, batch times, and operation sequences for the parts are
given in the table below. Determine (a) weekly production output of the shop and (b) whether this represents the
weekly plant capacity.
Time for
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Manufacturing Lead Time (MLT)
Production
Performance
Metrics
Example: Manufacturing Lead Time
A certain part is produced in batch sizes of 100 units. The batches must be routed through five operations to
complete the processing of the parts. Average setup time is 3.0 hr/batch, and average operation time is 6.0
min/pc. Average nonoperation time is 7.5 hr for each operation. Determine the manufacturing lead time to
complete one batch, assuming the plant runs 8 hr/ day, 5 days/wk.
Time for
15
Fixed and Variable Costs
Manufacturing
Costs
Example: Manual vs Automated production
Two production methods are being compared, one manual and the other automated. The manual method
produces 10 pc/hr and requires one worker at $15.00/hr. Fixed cost of the manual method is $5,000/yr. The
automated method produces 25 pc/hr, has a fixed cost of $55,000/yr, and a variable cost of $4.50/hr. Determine
the break-even point for the two methods; that is, determine the annual production quantity at which the two
methods have the same annual cost. Ignore the costs of materials used in the two methods.
Time for
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Direct Labor, Material and Overhead
Manufacturing
Costs
Example: Determinating Overhead Rates
Suppose that all costs have been compiled for a certain manufacturing firm for last year. The summary is shown
in the table below. The company operates two different manufacturing plants plus a corporate headquarters.
Determine (a) the factory overhead rate for each plant, and (b) the corporate overhead rate. These rates will be
used by the firm to predict the following year’s expenses.
Time for
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Direct Labor, Material and Overhead
Manufacturing
Costs
Example: Estimating Manufacturing Costs and Establishing Selling Price
A customer order of 50 parts is to be processed through plant 1 of the previous example. Raw materials and
tooling are supplied by the customer. The total time for processing the parts (including setup and other direct
labor) is 100 hr. Direct labor cost is $15.00/hr. The factory overhead rate is 250% and the corporate overhead
rate is 600%. (a) Compute the cost of the job. (b) What price should be quoted to the customer if the company
uses a 10% markup?
Time for
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Cost of Equipment Usage
Manufacturing
Costs
Example: Hourly Cost of a Machine
The following data are given for a production machine consisting of one worker and one piece of equipment: direct
labor rate = $15.00/hr, applicable factory overhead rate on labor = 60%, capital investment in machine = $100,000,
service life of the machine = 4 yr, rate of return = 10%, and applicable factory overhead rate on machine = 50%. The
machine will be operated one 8-hr shift, 250 day/yr. Determine the appropriate hourly rate for the machine.
Time for
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Cost of a Manufactured Part
Manufacturing
Costs
Example: Unit Cost of a Manufactured Part
The machine in the previous example is the first of two machines used to produce a certain part. The starting
material cost of the part is $8.50/pc. As determined in the previous example, the cost rate to operate the first
machine is $47.66/hr, or $0.794/min. The production time on the first machine is 4.20 min/pc, and there is no
tooling cost. The cost rate of the second machine in the process sequence is $35.80/hr, or $0.597/min. The
production time on the second machine is 2.75 min/pc, and the tooling cost is $0.20/pc. Determine the unit part
cost.
Time for
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