Unlike retail and service-oriented operations, manufacturing businesses face a special set of challenges regarding accounting and costing methods. Manufacturing businesses need to maintain a close watch on their books to ensure they generate the required amount of profit relative to their costs since they create products from scratch.
The process can become complicated and often includes a variety of variables while also relying on a few calculated assumptions to suit the dynamic nature of manufacturing accounting. The process also grows progressively more complex as your operation grows in size and may call for better and more efficient costing and accounting methods to ensure you’re running a sustainable business.
While keeping production costs to the minimum, businesses need to look to methods that allow them to make the best of their inventory, ensuring they produce quality products while also sustaining seamless cash flow. From inventory and labor expenses to taxes and bookkeeping costs, accounting for manufacturing companies entails several aspects that need to be considered.
This article lists the various methods of accounting and costing methods for manufacturing business owners to help you have a detailed understanding of all the concepts and principles involved.
The Types of Accounting Used in Manufacturing
The flow of manufacturing costs needs to be monitored by effective accounting strategies that can keep track of the many parameters involved in manufacturing a product. There are different methods that ensure the expenses involved in creating products are all tracked and recorded so that the company knows exactly where its money goes. Some of the common terminologies involved in manufacturing accounting are:
Budgets
All manufacturers create budgets that they adhere to when running their business during a defined fiscal period. However, unlike other businesses, a manufacturing budget might have to rely on more variable costs and make calculated guesses on inventory parameters and goods sold to maintain a seamless flow of cash in the business at all times.
Manufacturing budgets also require business owners to compartmentalize their budgeting plans for each stage of the production process. This ensures the business stays on track by assigning the appropriate sales prices for the products. Budgeting processes in factories and other industries rely considerably on historical data and production expenses to help managers make an informed estimate for future budgets.
Margins & Margin Analysis
Identifying the margin of profit you earn on the products your business creates and sells is an important part of manufacturing accounting. Margin analysis often involves tracking and accounting for all the costs involved in the production and then subtracting those costs from the total value those steps generate. Margin analyses are core strategies in streamlining the accounting process in a manufacturing business, helping entrepreneurs understand how well their business is performing and in also identifying prospects to extend the profitability of the production process.
Constraints
Identifying constraints is a key process of manufacturing accounting. This involves identifying potential concerns in the production process and finding appropriate solutions for them. Addressing the concerns will help you streamline production costs for better efficiency and allow you to run a lean manufacturing model that turns higher profits. If cash flow is a potential concern, addressing this constraint might involve securing manufacturing business funding beforehand to ensure it does not impede the overall production process in the facility.
Below are a few important accounting practices and techniques that are commonly deployed in manufacturing companies:
Management Accounting
This form of accounting in a manufacturing business primarily focuses on providing pointed information to the managerial staff to allow them to decide on core issues and matters regarding the manufacturing process and costs. Manufacturing accounting involves tracking the cost of goods sold, production costs, the efficiency of the manufacturing process, and the margin of profit. These details enable the production managers to attune production practices to ensure the business remains efficient in production and saves costs while maximizing returns from sales.
Financial Accounting
Financial accounting is primarily concerned with the creation of core financial statements such as cash flow reports, balance sheets, income reports, and profit statements. These documents are important when the manufacturing business needs to showcase its credibility and financial performance to investors or funding partners when raising capital. This form of accounting is also useful when the company undergoes regulatory checks and inspections. Financial accounting allows businesses to assess overall monetary health and manage finances in the business, making it a crucial aspect of manufacturing bookkeeping processes.
Cost Accounting
Manufacturers often deal with a vast array of costs incurred by their business’ production process. Keeping track of these costs is crucial to the seamless operations of the business. Cost accounting in manufacturing tracks production costs such as overheads, labor costs, and the cost of raw materials. Accounting for the industry’s expenses allows production managers to streamline and weed out any unnecessary steps in production and also determine a competitive price for their products.
Tax Accounting
Given that manufacturing also comes under numerous regulations and tax norms, tax accountants and the process of accounting taxes are crucial to a manufacturing firm. It is also important for business owners and accountants to be aware of the best and worst states for business taxes before setting up in a location that maximizes the business value. Tax accounting gives the company’s management an accurate picture of the taxes involved. This ultimately impacts profitability and also provides clarity on the various tax rates that apply to the stages of the production process in the manufacturing firm.
Auditing
Producing credible financial track records helps businesses reinforce investor faith and build a reputation for honesty. Auditing allows a manufacturing business to ensure that the accounting processes and standards deployed in analyzing a company’s finances are up to the mark. This helps entrepreneurs rest assured that their firm’s statements and records, and in turn the company’s adherence to business ethics and integrity. Accurate financial records are important for both capital expansion goals and to avoid legal repercussions arising from monetary misappropriation. Auditing is often conducted by both internal and external auditors.
Costing Methods for Manufacturing Businesses
There exists a variety of costing methods for manufacturing businesses that allow for the estimation of production costs. As each business is different, choosing the right method is key to running a successful manufacturing operation. A few of these costing methods are as follows:
Standard Costing
This method is by far the most common method used in manufacturing businesses to accurately estimate their costs. In standard costing, businesses assign standard costs for raw materials and labor when factoring them into inventory and production expenses. Standard costing enables manufacturers to follow through with the production process based on a set standard which can later be reassessed based on the variance they calculate by zeroing in on each stage of production.
The standard can also be adjusted accordingly wherever necessary. This method of costing is especially applicable to businesses that create similar products on a large scale. However, it also comes with numerous caveats such as the uniform maintenance of the set standard or the standard being too rigid and unrealistic when it comes to production.
Job Costing
Job costing often involves the cumulation of costs involved in procuring materials, labor expenses, and manufacturing overheads. The job costing process is perfect for businesses that custom-make products for their clients. This method is preferred by manufacturing businesses due to the ability of cost accountants to track the exact production costs involved, allowing them to arrive at an accurate price quote.
The direct costs are often traceable to the creation of the product and the maintenance of low variability in the overheads allows businesses to ensure a healthy margin of profit. However, for job costing to be used effectively, businesses must be capable of tracking real-time costs involved in creating products to ensure none of the expenses involved become elusive, causing accountants to lose track of them.
Activity-based Costing
Unlike job costing, activity costing relies on identifying all the activities in a manufacturing business and proportionately assigns the cost of activities to products based on their activity consumption. Activity-based costing or ABC costing can provide a unique picture when utilized to reveal products that generate profits vis a vis those that don’t. The business can then identify activities or production strategies that might require a revamp to ensure the profit margins are extended. While more specific and accurate, activity-based costing might cause businesses to undertake an unnecessary effort in case the products they produce are simplistic, with their costs being more straightforward to track.
Target Costing
This method considers numerous future costs that might impact the final cost of producing the product. The process essentially involves estimating these costs and ensuring that the company remains profitable. This method allows businesses to undertake a proactive approach so that they make a decent margin even if the market witnesses volatility. Target costing also allows businesses to foresee products that might not quite make the cut and discontinue them to capitalize on those that perform better. Despite its advantages, target costing requires constant monitoring of market trends and other parameters to remain rooted.
Direct Costing
The direct costing method in manufacturing accounting allows businesses to only consider variable costs without becoming encumbered with fixed expenses. Direct costing is primarily useful in undertaking pricing decisions for the short term. The method cannot be applied to long-term pricing decisions as it requires tangible information surrounding overhead costs and other aspects of production. Direct costing methods can be used in periods when the market sees changes and businesses might have to tweak previous decisions for the time being.
Sum up
With numerous accounting methods and costing strategies that manufacturing businesses can use, it is always important to ensure that cash flow is maintained to avoid hiccups during production. Manufacturing business owners can also consider financing options such as invoice factoring to maintain a streamlined flow of money in their operations regardless of the market outlook. The above methods will also help businesses choose what suits their operations the best, ensuring production performance is optimal and profits are commensurate with expectations.
