Accounting for Direct Costs vs. Labor Hours

You can track your small business' manufacturing costs several ways, but the most important thing you must do is separate direct costs and labor costs. This lets you know where you are spending your money and allows you to keep costs down. Solid accounting practices keep these two manufacturing expenses separate, and you will be more likely to stay on top of expenditures if you review direct costs and labor costs periodically.

Direct Materials Costs

  1. Your direct materials costs cover any material that has a physical presence in the finished product. You buy these materials periodically, so that your workers will have all the elements they need to manufacture your products. Your purchases from materials vendors should be kept in a separate category in your accounting, so that they are distinct from any other expenses you incur in the manufacturing process.

Labor Hours

  1. Account not only for the labor hours that go into your manufacturing process but the dollar value of those labor hours. You can find this figure by averaging the wages you pay to your labor force and multiplying that average by the actual hours spent manufacturing during a shift. Look at your labor costs frequently to make sure you are not spending too much on wages compared to sales revenue. How much is too much depends on your industry, but if you find yourself spending half your manufacturing money on production wages, you should start looking for ways to cut back on employee expense or increase production.

Alternate Measure of Labor

  1. If you use a lot of machinery in your manufacturing process, you may find it useful to account for machine hours instead of labor expenses. You can assign a cost value to labor based on how many hours each worker is using machines. Don't count electricity and depreciation of the machines. Simply account for how much you pay labor to operate machinery per machine hour. This will take out breaks and lunches and let you see how much actual productivity you are getting for your dollars.

Indirect Materials Costs

  1. Do not count items such as solder, twine, tape and other markers in your direct materials costs. These are indirect materials. Though they may be vital to your manufacturing costs, they should be counted with general manufacturing expenses along with electricity, rent and depreciation of equipment.