Bills of materials and work orders: how to know what a product really costs
A cost calculated from the bill of materials tells you what a product should cost. What it really costs only shows when the bill of materials is compared with the work order.
Most manufacturing companies know the selling price of every product by heart. Asked what that product costs, the answer is usually a figure from a calculation made when the product was introduced. Between that figure and reality there is often a gap large enough to eat the whole margin.
The bill of materials is the plan, the work order is reality
A bill of materials with its routing describes what is needed for one piece or one batch: which materials, in what quantities, which operations and how much time on which machine. It is the recipe.
A work order records what really happened during production: how much material was issued, how many hours were spent, how many pieces came out good and how many went to scrap.
The bill of materials answers the question of what it should cost. The work order answers what it did cost. A company that has only the first is working with an assumption, not with data.
What product cost consists of
- Direct material. The quantity from the work order multiplied by the purchase price. The first trap hides here: the last purchase price and the average stock price can differ more than you think.
- Direct labour. Hours spent on the order multiplied by the cost of an hour. The cost of an hour is not net pay, but the total cost of the employee divided by effective working hours. We cover this in the article on what an employee really costs the employer.
- Machine time. Depreciation, energy, tooling and maintenance, reduced to an hour of operation.
- Production overheads. Rent of the hall, supervisors, quality control, heating. They cannot be assigned to a single order, so they are allocated by a key, most often labour or machine hours.
- Scrap and rework. Material and time spent on pieces that could not be sold.
Where the numbers usually diverge
The bill of materials is out of date. It was set when the product was introduced, and since then the supplier, the sheet thickness or the order of operations has changed. Nobody updated it because there was no reason to until the cost was checked.
Scrap is not included. If five pieces out of a hundred go to waste, you paid for the material for those five and did not sell them. A bill of materials without a scrap percentage understates cost by exactly that amount.
Setup is not counted. Setting up a machine takes the same time for a batch of ten as for a batch of a thousand. With small batches, setup can cost more than production itself, and it is often missing from the calculation.
Time is estimated, not measured. The operation is entered as four minutes. It really takes six, because of waiting for material, tooling or inspection.
Overheads are allocated by habit. An allocation key set several years ago no longer matches how production looks today.
An example
Take a product with a selling price of EUR 100. The figures are invented, but the proportions are typical.
| Per bill of materials | Per work order | |
|---|---|---|
| Material | 42.00 | 45.50 |
| Labour | 18.00 | 23.00 |
| Machine | 9.00 | 9.50 |
| Production overheads | 11.00 | 11.00 |
| Product cost | 80.00 | 89.00 |
| Margin | 20.00 | 11.00 |
Material is more expensive because three pieces in a hundred went to scrap and because the price of sheet metal has risen. Labour is more expensive because machine setup took longer than planned and the batch was smaller. None of these differences is dramatic. Together they halved the margin.
A company looking only at the left column thinks it earns twenty per cent on the product. It gives a ten per cent discount to an important customer and believes ten per cent remains. In reality one per cent remains.
What is done with this information
Comparing the bill of materials with the order is not an end in itself. Concrete decisions follow from it:
- Correct the bill of materials where the deviation repeats, so that calculations and quotes start from accurate figures.
- Change the price or minimum batch for products that really lose money.
- Find the cause of scrap, once it is clear that it is tied to a particular machine, shift or supplier.
- Steer sales towards products that really carry margin, not those that have it only on paper.
What is needed to track it
- Material is issued to an order, not generally “to production”. Without that, consumption cannot be tied to a product.
- Time is recorded per order and operation. Start and end are enough, from a terminal or scanner, with no paper retyped at the end of the shift.
- Scrap is recorded with quantity and reason.
- The bill of materials has an owner and a date of last change.
- Deviations are reviewed regularly, ideally once a month, with controlling that translates them into money.
This is hard to maintain in spreadsheets, because each of these figures arises in a different place and at a different time. We described why in the article on Excel in manufacturing.
If you want to know what your products really cost, get in touch. We can start with an analysis of a few products on existing data, and then see what needs to change in your records for that picture to be available all the time.