How to Calculate Manufacturing Overhead: Formula + Examples

Manufacturing overhead costs can make or break your business profitability, yet they're often misunderstood and miscalculated. Getting a handle on these indirect expenses is crucial for accurate pricing, budgeting, and financial decision-making.

In this guide, we'll break down exactly what manufacturing overhead is, how to calculate it with a straightforward formula, and walk through real-world examples so you can apply these concepts to your operations.

What Is Manufacturing Overhead?

Manufacturing overhead includes all the indirect costs needed to run your production facility. Unlike direct materials and direct labor that go straight into making your products, overhead covers everything else required to keep your manufacturing operations running.

Think of it this way: if your factory suddenly had no products to make, these would be the costs you'd still have to pay.

Common manufacturing overhead costs include:

• Rent and utilities for production facilities
• Depreciation on manufacturing equipment
• Maintenance and repairs
• Factory supplies not directly used in products
• Quality control costs
• Production management salaries
• Factory insurance
• Property taxes on manufacturing facilities

These costs don't directly touch your products but are absolutely necessary for production to happen.

The Manufacturing Overhead Formula

Calculating your manufacturing overhead rate uses this basic formula:

Manufacturing Overhead Rate = Total Manufacturing Overhead / Allocation Base

The allocation base is what you choose to distribute overhead costs against. Common allocation bases include:

• Direct labor hours
• Direct labor cost
• Machine hours
• Units produced

Your choice depends on what most accurately reflects how overhead costs behave in your specific operation. For labor-intensive manufacturing, direct labor hours often works well. For highly automated processes, machine hours might be more appropriate.

Step-by-Step Calculation Process

1. Identify all manufacturing overhead costs for the period
2. Add them together to get your total manufacturing overhead
3. Choose an appropriate allocation base based on your operations
4. Calculate the value of your allocation base for the period
5. Divide total overhead by the allocation base to get your overhead rate

Once you have your overhead rate, you can apply it to each product based on how much of the allocation base that product consumes.

Real-World Example: Furniture Manufacturing

Let's say you run a furniture manufacturing business with these monthly costs:

• Factory rent: $8,000
• Utilities: $3,500
• Indirect materials (glue, sandpaper, etc.): $2,000
• Maintenance: $1,500
• Production supervisor salary: $5,000
• Depreciation on equipment: $4,000
• Factory insurance: $1,000

Step 1: Add up your total manufacturing overhead costs. $8,000 + $3,500 + $2,000 + $1,500 + $5,000 + $4,000 + $1,000 = $25,000

Step 2: Determine your allocation base. Let's say your furniture manufacturing is labor-intensive, so you'll use direct labor hours. Your team worked 2,000 direct labor hours this month.

Step 3: Calculate your manufacturing overhead rate. $25,000 ÷ 2,000 hours = $12.50 per direct labor hour

This means for every hour of direct labor spent making a product, you need to allocate $12.50 of overhead to that product.

Step 4: Apply this to specific products. If a dining table takes 5 hours of direct labor to make, you would allocate: 5 hours × $12.50 = $62.50 of manufacturing overhead to each table.

Manufacturing Overhead in Different Industries

Firearms & Accessories

In firearms manufacturing, overhead typically includes specialized safety equipment, strict quality control processes, and regulatory compliance costs. Machine hours often serve as a good allocation base due to the precision equipment required.

Automotive

Automotive manufacturers balance high automation with skilled labor needs. Their overhead includes large facility costs, extensive testing equipment, and significant utility expenses. Many use a hybrid allocation base or separate overhead pools for different production stages.

Electronics

Electronics producers face substantial overhead in specialized equipment, clean room environments, and testing apparatus. Machine hours typically work best as an allocation base, with particular attention to energy costs for sensitive manufacturing equipment.

Adult & Lingerie

This industry's overhead often focuses on specialized cutting and sewing equipment, along with strict quality control for fabrics and elastic components. Direct labor hours frequently serve as the allocation base due to the hands-on nature of production.

Home & Furniture

Furniture makers have significant overhead in workshop space, woodworking machinery, and finishing equipment. Given the mix of machine work and craftsmanship, many use a combination of machine hours and labor hours as allocation bases.

Apparel & Fashion

Apparel manufacturing overhead includes pattern-making technology, cutting equipment, and production floor space. Direct labor hours are commonly used for allocation, though some operations with automated cutting might use machine hours.

Common Mistakes in Overhead Calculation

Avoid these pitfalls when calculating your manufacturing overhead:

Mixing in non-manufacturing costs. General business expenses like corporate office rent or sales team salaries don't belong in manufacturing overhead.

Using the wrong allocation base. If you choose machine hours but your overhead costs are driven more by labor time, your product costs will be distorted.

Overlooking seasonal variations. Many overhead costs remain fixed while production volumes change, causing rate fluctuations throughout the year.

Forgetting to update calculations. As your operations evolve, your overhead structure and allocation methods should too.

Tips for Managing Manufacturing Overhead

Once you've calculated your overhead rate, use this information to improve your operations:

Identify cost reduction opportunities. Look for the largest overhead categories and brainstorm ways to optimize them without compromising quality.

Check for underutilized capacity. High overhead rates might signal you're not fully utilizing your production capacity.

Refine product pricing. Make sure your prices fully account for all overhead costs to maintain profitability.

Budget more accurately. Use historical overhead rates to create more precise financial projections.

Consider ABC costing for complex operations. Activity-Based Costing provides even more precise overhead allocation for businesses with diverse product lines.

Tracking Overhead Costs Effectively

Good manufacturing overhead management starts with good tracking systems:

• Set up dedicated ledger accounts for each overhead category
• Review overhead spending monthly
• Compare actual overhead to budgeted amounts
• Track your overhead rate over time to spot trends
• Document your allocation methodology for consistency

Conclusion

Manufacturing overhead might seem less tangible than direct materials or labor, but it's just as important to your bottom line. By accurately calculating and monitoring these costs, you gain clearer insight into true product profitability and find opportunities to streamline operations.

The basic formula is straightforward: divide total manufacturing overhead by your chosen allocation base. The challenge lies in identifying all relevant costs and selecting the most appropriate base for your specific operation.

Remember that overhead calculation isn't just an accounting exercise. It provides crucial data for pricing decisions, budgeting, and operational improvements. Taking the time to get it right pays dividends in more accurate cost information and ultimately, better business decisions.

By following the steps and examples in this guide, you'll be well on your way to mastering manufacturing overhead calculation and using that knowledge to boost your manufacturing efficiency and profitability.

Manufacturing overhead Frequently Asked Questions

What costs should be included in manufacturing overhead if I have multiple fulfillment sources?

Manufacturing overhead should include all indirect costs related to your production facilities across all fulfillment sources. This includes rent, utilities, and maintenance for each manufacturing location, as well as supervisory staff, equipment depreciation, and factory insurance. The key is to track these costs separately for each fulfillment source, then combine them when calculating overall product costs.

How do I allocate overhead when I use both internal manufacturing and third-party partners?

For a mixed fulfillment model, create separate overhead pools for your internal operations and for managing external partners. Internal overhead includes traditional factory costs, while your external partner overhead includes costs of vendor management systems, quality control for incoming shipments, and staff who manage these relationships. Calculate separate overhead rates for each fulfillment channel.

Should I use the same allocation base for all my product lines?

Not necessarily. If you have diverse product lines with different production methods, consider using different allocation bases for each. For example, labor-intensive products might use direct labor hours, while highly automated lines might use machine hours. The goal is to choose the base that most accurately reflects how overhead costs behave for each product type.

How often should I recalculate my manufacturing overhead rate?

For businesses with 500+ monthly orders and multiple fulfillment sources, quarterly recalculation is generally sufficient. However, you should also recalculate whenever you add a new fulfillment source, significantly change production methods, or experience major shifts in overhead costs. Seasonal businesses might need to calculate monthly rates during peak periods.

How do changes in order volume affect my overhead calculations?

As order volume increases, your overhead rate typically decreases because fixed costs are spread across more units. This is particularly important for multi-source brands that might shift fulfillment between sources based on volume. Track how your overhead rate changes at different volume levels to optimize your fulfillment routing decisions.

What's the best way to account for overhead in dropshipping relationships?

For retailers with dropship partners, your "manufacturing overhead" consists of costs to manage these relationships, including vendor management systems, staff who handle partner communication, quality assurance programs, and returns processing. Allocate these costs based on the number of orders, SKUs, or revenue generated through each dropship partner.

How does manufacturing overhead calculation differ for print-on-demand operations?

For POD brand licensees, your overhead includes costs of design file management systems, license compliance tracking, quality control specific to print quality, and systems that route orders to appropriate POD partners. Consider using "number of unique designs" as an allocation base since much of your overhead relates to design management rather than traditional manufacturing.

Should marketplace fees be included in manufacturing overhead?

For vendor marketplace retailers, marketplace fees should not be included in manufacturing overhead. Instead, treat these as selling expenses. Your overhead should focus on costs of managing the platform, vendor onboarding, quality control systems, and other behind-the-scenes operational costs that support your vendor network.

How detailed should my overhead tracking be with multiple fulfillment sources?

With multiple fulfillment sources, track overhead in enough detail to understand costs by location and fulfillment type. Set up separate ledger accounts for each fulfillment source or create a coding system that allows you to filter overhead costs by location. This granularity helps identify cost-saving opportunities and optimize your fulfillment strategy.

Can I use the same overhead rate for both B2B and B2C orders?

B2B suppliers with both business and consumer channels should calculate separate overhead rates for each. B2B orders typically require different handling, quality control, and documentation than B2C orders. Even if they're fulfilled from the same facility, your overhead allocation should reflect these differences in processing requirements.

How do I handle overhead for seasonal products manufactured year-round?

If you manufacture seasonal products throughout the year, calculate your overhead based on annual costs rather than monthly or quarterly figures. This creates a stable overhead rate that doesn't fluctuate dramatically during off-peak production periods. You can then apply this rate consistently regardless of when items are manufactured.

Ready to optimize your manufacturing overhead across multiple fulfillment sources?

Flxpoint brings all your inventory, orders, and fulfillment channels together in one platform. Schedule a demo today to see how we can help streamline your operations and improve profitability.

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