How to handle estimated manufacturing costs?

Introduction

In the pre-sales process, one of our manufacturing business owners using ERPAG complained that all suppliers have made price adjustments of iron in the market which have significantly increased. Raw materials are mostly made of iron as they are an integral part of each sub-component and every product.

He had a question: How to handle estimated manufacturing costs? Our response was pretty simple: Use ERPAG.

When the market is stable and solid, usually manufacturers have one primary supplier for each type of component, and this is a well- established business principal. However, when costs of input items increase, ignoring or wrong handling of estimated costs might lead to negative margin and non-competitiveness of the product on the market.

The most common reasons for increased price of inputs are:

• Inflation
• Disruption in the supply chain
• Increased freight costs
• Exchange rate differences
• Protectionism
• Increased cost of labor

Regardless of the reason for increased costs of input, handling is done in the same way. In this blog, we will explain how to handle those changes in a simple and efficient way.

Basic terms

Manufacturing cost is the amount of money we need to spend to produce a product (amount without profit included).

There are two basic components:

• Direct cost – This type of expense can only be calculated only in the moment of manufacturing for a specific product (raw materials, direct labor, manufacturing overhead).
• Indirect cost – These are costs that can’t be directly added to a specific product (office expenses, rent).

There’s also:

• Estimated cost – This is a presumption of the costs for the product. This is the foundation for planning selling price. It is calculated before the physical start of the manufacturing.
• Actual cost – This amount shows how much exactly the manufacturing process costs. It is calculated after finishing manufacturing. If indirect costs are allocated, billing is possible at the end of the “billing” period (for example monthly, quarterly).

Usually, for simpler calculations, small manufacturing businesses calculate expenses only with direct costs. In this blog, we will focus only on estimated cost.

ERPAG product estimated cost

If the product is purchased from the supplier (fulfillment type “supplier“), in that case, estimated cost is a sum of “purchase price” and “landing cost”.

Note: More information about Landed cost can be found on this link:

In case it is a product that needs to be manufactured (fulfillment type “Bill of materials“), the estimated cost is a sum of all estimated costs of components and work operations.

Costs of direct labor can be calculated when we multiply the estimated time of work operation with “Cost per hour” from work operations.

Note: If the “Bill of material” product type has subcomponents (multi-level BOM), changes on any subcomponent or component will automatically reflect on all related products regardless of a level where the component is “inserted”.

A useful tool for controlling components is “Where used”.

This option shows all final products and subcomponents where the item has been used.

If we decide to change the purchase price on the item from the picture above, all products will be automatically corrected.

Changes in Exchange rates

ERPAG supports multi currency completely. In case you are having suppliers with payments in a different currency while changing exchange rate, ERPAG will automatically update all purchase prices related to changed currency.

Changes of rates can be done manually or through API service.

The example of changing USD rate from 0.7554 to 0.800.

The purchase price in USD remained the same, but the price in domestic currency (CAD) is being changed. And changes affected every BOM related to that product. In our example estimated cost for SKU:0001 has changed from 311.22 (CAD) to 308.84(CAD).

Since CAD got “stronger” related to USD, the estimated cost has been reduced. As we saw in the example of the exchange rates, changes might have a positive or negative effects on the price.

More information about the exchange rate and API integration can be found on the following link:

Update supplier price lists in ERPAG

Each supplier in ERPAG has its own price list. When suppliers make price changes, those changes can be entered manually in ERPAG or imported from spreadsheets.

After saving changes, ERPAG also automatically updates the estimated cost on all related products.

Note: There is an option to automatically update the supplier price list when a supplier invoice is received.

This option needs to be set for each supplier. Practically, with this option, an update of the supplier price list can be done from a Purchase order.

ERPAG multiple suppliers priority

Each product in ERPAG can have multiple suppliers. In estimated cost calculation, only main supplier prices are included. If there is more than one supplier, the supplier with number 1 priority will be a primary supplier.

Note: Like other changes, change of the main supplier(change of priority) also affect the estimated cost, ERPAG will automatically update estimated cost to all related products.

ERPAG multiple suppliers Bulk edit

Since changes on the market are very frequent, in practice, we saw that changing priority item by item is very time-consuming. This is why we have a “Bulk edit” option in ERPAG.

It is basically an input form where suppliers are grouped vertically e.g. data info is in columns, while rows are reserved for items.

Note: Since the data is grouped in a column, because of transparency and performance, currently we set the limit on 9 different suppliers. We suggest when items are selected from the same category, you select suppliers from the same branch. For example, it makes no sense to Bulk edit raw materials made of wood with raw materials from metal. It is not very likely that metal raw materials supplier is also wooden raw material supplier.

Entering data is done through the classic ERPAG table. The only difference is that adding or removing new suppliers needs to be done using a button on the right (check image below).

By adding a new supplier; new columns are open and grouped according to that supplier.

“Removing” supplier practically removes certain columns from the table.

Note: If a supplier is removed, while saving, items that are included in Bulk edit will be removed as well.

Besides “priority” in this table other information can be entered as well (for example purchase price, shipping days, etc…) After saving, appropriate supplier price lists will be updated.

Choosing priority can be done manually, by simply entering a number. During entering data, ERPAG will automatically reorder the priority of other suppliers.

The other way is by using the “wand button” on the right side menu. By choosing an option, priority will be decided based on values. The lowest value will have priority 1, the next one is number 2, etc.

Advanced priority setup

If choosing a supplier requires more than the lowest price, then we can use a “scoring” supplier. For example, besides the lowest price, we care about reliability and the number of days for the supplier to deliver the required item/s. We can always export these data to a spreadsheet and conduct scoring logic, and after calculation import again in ERPAG. For technically-advanced users, that can be done via custom formula.

More information about custom formulas can be found on this blog:

“Score” is shown as a separate column that can be filtered/sorted and based on data from that column fill out the priority column.

An even more advanced option is via “Blockly script”.

A script in the picture above will be recorded in a database and can be executed when necessary. Also, it is possible to have more different scripts.

More Blockly script examples can be found on our youtube channel:

https://www.youtube.com/channel/UCv5Iypb5TCgIdEjKdaXp-yw/videos

Comparing prices in ERPAG

It is always a good practice to reevaluate suppliers, i.e check their prices. When suppliers are lifting the prices by small amounts, it often goes under the radar. Change of the supplier priorities is not automatic, so in order to always get optimal prices, comparing supplier prices can always come in handy.

This option can be found in supplier details. It is identical to “Bulk edit multiple suppliers” The only difference is this only affects items imported in the suppliers price list.

Negative estimated margin

On the item page, the “default selling price” field will be highlighted with a different color if the value is less than the estimated cost.

In that way, ERPAG suggests that something is not quite logical i.e the estimated margin is negative. When it comes to a big number of items, as well as with changes that are not direct (eg. exchange rate, raw material cost, etc.) it is not practical to activate each item to check this.

For faster scanning Negative margin, we have created a new Snippet in the products and services list.

Whenever this list is activated, it will show all items with a Negative estimated margin. With one click of a mouse, a list will filter and show all “problematic” items.

Note: Negative estimated margin works for multi-level BOM as well.

More information about snippets in ERPAG can be found on this blog:

Selling price based on Estimated cost

In ERPAG there is a possibility to automatically calculate selling price based on markup/margin percent.

This means that the default selling price is calculated every time the estimated cost changes. Simply set the desired margin/ markup percentage, and that’s it!

The advantage setting makes sure that you will always have estimated profit no matter the change of estimated cost. The disadvantage is that even with the slightest change in estimate cost, you will have a new price.