BUDGET 4  - DEVELOPING YOUR DIRECT MANUFACTURING LABOR BUDGET

After the Purchase Budget has been Developed, the next step is to Develop Your Direct Manufacturing Budget. As the name implies, the Direct Manufacturing Labor Budget, is used ONLY by Manufacturing companies. Therefore, you may omit this Budget if your business is NOT considered a manufacturing company. If, on the other hand, your business involves manipulating raw materials into "finished" product, you will be required to develop a Direct Manufacturing Labor Budget.

Since Murray does NOT plan to manufacture his product (IE the diskette, listing the organizations who provide scholarships to University Students), he can omit this Budget.

Direct Manufacturing Labor Costs are labor costs that directly relate to manufacturing a product. Furthermore, direct labor can be described as the labor of those people who work, either with machines or hand tools, specifically on the raw materials to convert them into finished products. The costs associated with direct labor become part of the cost to produce each finished unit or product (IE used to determine each unit's Total Product Cost). Direct Labor Costs depend on the type(s) of product produced, labor rates, hiring plans & procedures, and the production methods employed by the company.

The Direct Manufacturing Labor Budget attempts to determine two things;

Part 1   Determine Your Total Forecasted Direct Manufacturing Labor Cost;
Part 2   Determine Your Direct Manufacturing Labor Cost On A Per Unit Basis

Part 1 - Determine Your Total Forecasted Direct Manufacturing Labor Cost
The following formula is used to determine your Total Forecasted Direct Manufacturing Labor Cost for each forecasted period or business year. (Assume all values)

Notice, the number of units forecasted to be produced for each product during the year is multiplied by the number of hours required to make each product. The resulting figure becomes known as the total number of hours needed to produce each product during the year. The total number of hours needed to produce each product during the year is then multiplied by the hourly rate paid to each direct laborer. The resulting amounts are considered your direct labor cost for each product. All the direct labor costs are added together to arrive at your Total Direct Manufacturing Labor Costs for the year.

If you are developing a business plan for an investor, you will be calculating your Direct Manufacturing Labor Cost Budget for a three year period. Moreover, if your forecasted periods are 200X, 200Y, and 200Z, then you will determine your Direct Manufacturing Labor Cost Budget for each of these years (IE 200X, 200Y, and 200Z).

Part 2 - Determine Your Direct Manufacturing Labor Cost (Per Unit)
Part 2 of the Direct Manufacturing Labor Budget, calculates the cost of direct labor for each unit produced in each forecasted business year. To do this, simply divide your total direct labor cost for each product by the number of units you plan to produce of each product. Using the example from above, we can calculate the Direct Labor Cost Per Unit as follows;

As you can see, this company would spend $50.00 on direct labor for each unit of "Product A" it makes or produces. It would spend $40.00 on direct labor for each unit of "Product B" it makes or produces. And finally the company estimates that $20.00 will be spent on direct labor for each unit of "Product C" it produces. The company would use the same method to calculate its Direct Labor Cost Per Unit for its second forecasted year and its third forecasted business year.

Knowing how much direct labor (in dollar) goes into producing each finished product is extremely important to a manufacturer. It assists them in determining their total cost to produce each product, and ultimately assists in setting their product's price(s). Furthermore, a manufacturer will consider three cost items when determining its Total Cost to produce one finished product (IE Total Product Cost). These cost items include;

1.   The Raw Materials needed to make one finished unit (Budget 1); 

2.   Direct Labor Costs needed to produce one finished unit; (Budget 4);

3.   Factory Overhead used to produce one finished unit (Budget 5)

The sum of these three costs, on a per unit basis, tells a manufacturer how much it will cost them to produce or make one finished unit or product (IE Total Product Cost per Unit). For instance, lets assume the XYZ Company determines the following costs are needed to produce one unit of finished product;

• $154.00 worth of raw materials are needed to make one finished product;
• 2 hours of labor, at $20 per hour, ( IE $40) is needed to make one finished product;
• $6.00 of factory overhead is required to produce one finished product.

Therefore, the company's Total Product Cost or total cost to produce one finished unit is $200  (IE $154.00 + $40.00 + $6.00 = $200 per unit).