Manufacturing Overhead – What Is It and Why Does It Matter?

Originally posted on Insight Solutions Blog

By Sophie Luo, Insight Solutions

You may have come across the term overhead on the invoice sent by your supplier enough times to remember that your company need to pay for it.

As an resourceful and effective project manager, you know that getting to know each expenditure and then identifying ways to reduce the overall costs should be your perpetual goal.

In the case of overheads, what should you know about it? What can you do to reduce it?

What is overhead?

Overhead or overhead expenses refers to the expenses that are indispensable in business, but can’t generate profits directly. Such costs can’t be traced or identified with particular cost units, unlike that of direct material and direct labor.

For example, factory rent is indispensable in that it allows employees to work in the factory to make products that can generate profits. This is why the rent is part of overhead.

That said, it shouldn’t be hard to understand that your supplier counts the overhead as part of the finished product or component costs. To be more exact, the overhead you see should be manufacturing overhead.

Manufacturing overhead, also known as indirect costs, production overhead, factory burden, and manufacturing support costs, refer to the indirect factory-related costs in the process where a product or a component is made. It’s a crucial factor for the supplier to decide how much to charge you.

Examples of manufacturing overhead

Generally speaking, manufacturing overhead includes the following items:

• Salaries for maintenance personnel, manufacturing managers, materials management staff, and quality control staff and even janitorial staff;
• Depreciation of assets and equipment;
• Property taxes on production facilities;
• Rent for a factory building.

Administrative overhead is different from manufacturing overhead; you aren’t usually charged for the administrative overhead. But you should also know what it includes, so you should see what you can do to reduce the administrative or supporting costs in your organization. This is also a way to earn more for your company.

Examples of administrative overheads

Here are some of the most common items for administrative overheads:

• Corporate salaries;
• Outside audit and legal fees;
• Bad debt;
• Office supplies;
• Administration and sales office lease, utilities, travel and entertainment, and telephone fees.

Why manufacturing overhead matters

Just as the saying goes, keep your friends close and your enemies closer, the more you understand your suppliers’ internal business realities, the better negotiator you will be. For you, the project manager, manufacturing overhead breakdown gives you critical insights into the price charged by your supplier.

You’ll have more bargaining power when talking to your supplier about reducing the product price, and you’ll have better judgement when receiving different quotes from potential suppliers, because you have a clue about what the manufacturing overhead comprises. End result? Reduce costs for your company and increase  profits.

If you want to develop a good relationship with your supplier, your knowledge and understanding of the manufacturing overhead could be of great use. For example, you can suggest that they find ways to reduce waste and increase manufacturing efficiency, so as to reduce the product price. This is a win-win approach for all parties involved.

And of course, if you have any questions about this or any other issue related to supplier management, contact us.