How to calculate Inventory Cost?
Below image gives an idea on the components that are required to arrive at the Finished Goods costing and also how to calculate the Inventory costing. Here we are making an attempt to explain the inventory cost and how its calculated etc?
Recently we spoke few Customers, who are worried about the increasing costs of doing the business. One of the factor was inventory cost and they were struggling to find the cost in a more proper and scientific way. So we asked few questions to find how the inventory costing is done by them?
- What’s your cost of Finished Goods? How you arrive?
- How much Raw Materials costs have increased in last one year?
- Whats the cost of labour or Machine costs that incur?
- How much is the Electricity and other expenses?
Many business owners have a fair idea of their Inventory Carrying cost of the raw materials and how much them goes into Finished Goods. But do they address the real costs?
No. Because customer Accounting software doesn’t allow. So how the inventory costing is done? What are the parameters to be considered?
So many business owners depend on Excel document with many parameters and these are identified at the time, when the Finished Goods (FG) Costing was arrived and when the Quote was given at the beginning. But as the time passes, the Raw materials (RM) cost goes up and these are not added back to FG Costing to arrive at the real cost and increase the FG selling cost. Many follow this below shown costing approach. We took an example of an Automobile Component manufacture that manufacturers and sell U-Bolts. The figures are fictional and not an actual
|No||Major Components||Details||Cost (Rs.)|
|1||Raw Materials||EN-8 materials of 100mm length and Dia16 mm||100|
|Packaging Material costs||3.5|
|3||Total cost of Finished Good||118.50|
|4||Overhead costs||30% of total cost||35.55|
|5||Profit Margin||30% of the total Cost including Overhead cost||46.25|
|6||Total Selling price||200.30|
In this rough costing there are many things are missing
- Cost of raw materials – Typically RM price changes based on the demand and Supply. So the cost could go up or down. So the right model is to have a Weighted Moving Average Cost (WMAC) as it takes into the account the Past costs and also the Current purchase prices. AcTouch.com uses this model.
- Activity based costing – (ABC) – Each activities costs would increase depends on the labours who work on the machines. You can not take an Average cost as the employee costs changes every year and its advisable to take the actual labour costs that are used for those machining activities. This ensures that all the costs are factored.
- Subcontracting costs – If we are sending the materials to an outside agency that does hardening or blackening operations and these costs should to be added to your RM costs. Many customers don’t know how to do this?
- Other costs
- Furnace oil used for the operation
- Electricity consumed
- Other overheads
- Biggest problem is how these are added to the RM costing at the time of Conversion to FG?
Many SME Business Owners don’t follow this because their Accounting Software is old and doesn’t allow these dynamic changes.
Let’s check how ACTouch.com would do this?
|No||Major Components||Details||Cost (Rs.)||Whats the problem?||How AcTouch.com helps?|
|1||Raw Materials||EN-8 materials of 100mm length and Dia16 mm||100||Purchase price may change for Every Goods receipt||At the time of Purchase, we average the costs by WMAC method|
|Packaging Material costs||3.5||Purchase price may change for Every Goods receipt||At the time of Purchase, we average the costs by WMAC method|
|2||Operation cost||Cutting||2.00||Once in 6 to 12 months||Labour, Machine costs|
|Bending||2.00||Once in 6 to 12 months||Labour, Machine costs|
|Threading||5.00||Once in 6 to 12 months||Labour, Machine costs|
|Hardening||4.00||Once in 6 to 12 months||Labour, Machine costs|
|Blackening||1.00||Once in 6 to 12 months||Labour, Machine costs|
|Packaging||1.00||Once in 6 to 12 months||Labour, Machine costs|
|Total cost of Finished Good||118.50|
|Overhead costs||30% of total cost||35.55||Changes once in a year||Bill of Materials (BOM) Overhead costs|
|Profit Margin||30% of the total Cost including Overhead cost||46.25||Depending on Business Owners||Sales Decision and upload the Price Lists|
|Total Selling price||200.30|
Fix your product demo at your convenience.