The 7 elements of product cost
| # | Element | What to include |
|---|---|---|
| 1 | Direct material | Raw material and components at landed cost (price + freight + unloading) |
| 2 | Material wastage / rejection | Process loss, scrap, rework, minus scrap sale value |
| 3 | Packing material | Cartons, bags, labels, pallets, strapping |
| 4 | Direct labour | Wages of people working on the product, per unit of output |
| 5 | Power and fuel | Machine power, furnace or boiler fuel, per unit |
| 6 | Factory overheads | Supervision, maintenance, depreciation, factory rent, QC |
| 7 | Admin, selling and finance cost | Office salaries, freight outward, commissions, interest on working capital |
Elements 1 to 6 give the factory cost. Adding element 7 gives the total cost, which is what your price must cover before any profit.
Worked example (illustrative)
A unit makes a product with a monthly output of 10,000 units. The figures below are an example to show the method, not industry benchmarks.
| Cost element | Basis | ₹ per unit |
|---|---|---|
| Raw material | 2.0 kg × ₹60 landed | 120.00 |
| Wastage | 4% of material, net of scrap sale | 4.10 |
| Packing | Carton + label | 6.50 |
| Direct labour | ₹3,00,000 / 10,000 units | 30.00 |
| Power and fuel | ₹1,20,000 / 10,000 units | 12.00 |
| Factory overheads | ₹2,00,000 / 10,000 units | 20.00 |
| Factory cost | 192.60 | |
| Admin and selling | ₹1,50,000 / 10,000 units | 15.00 |
| Freight outward | Average per unit | 5.00 |
| Finance cost | Interest on 60 days' working capital | 3.80 |
| Total cost | 216.40 |
If this product sells at ₹225 after discounts, the real margin is about ₹8.60 per unit, under 4%. Looking only at raw material (₹120 against a ₹225 price), the same product appears to earn ₹105 per unit.
Where costing usually goes wrong
- Using purchase price, not landed cost. Freight and handling can add several percent.
- Ignoring wastage and rejection, the most common hidden loss.
- Spreading overheads by sales value instead of machine hours or actual usage, which makes simple products subsidise complex ones.
- Using full capacity output when actual output is lower, which understates cost per unit.
- Forgetting finance cost on long credit customers.
Using the cost sheet for pricing
- Set a floor price at total cost plus minimum margin. No salesperson goes below it.
- Review the cost sheet whenever a major input price changes, not once a year.
- Rank products by margin per unit and margin per machine hour, then push the best ones.
- Price credit: a 90-day customer costs more to serve than a 30-day customer. Read how to fix cash flow in MSMEs.
Once the cost sheet is in place, the next step is reducing it. See 12 ways to reduce manufacturing cost without cutting quality.
TBS builds product costing, margin visibility and pricing systems for manufacturers. See cost reduction and product costing consulting.
Want this built for your business?
TBS installs these systems inside MSMEs and stays until your team runs them without you. Start with a 45-minute strategy session with the founder, or take the 20-minute Business Depth Assessment to see where you stand.
Frequently asked questions
What is included in the cost of a product in manufacturing?
Direct material at landed cost, wastage and rejection, packing, direct labour, power and fuel, factory overheads, and admin, selling and finance costs allocated per unit.
What is the difference between factory cost and total cost?
Factory cost covers everything incurred to make the product in the plant. Total cost adds administration, selling, freight outward and finance costs. Pricing must cover total cost.
How often should product costing be updated?
Whenever a major input such as raw material, power or wages changes significantly, and at least quarterly for fast-moving products.
How should overheads be allocated to products?
On the driver that best reflects usage, such as machine hours, labour hours or batch count, rather than sales value, so complex products carry their true share.
Munishh Latawa is the founder of The Business Studio, an execution-first MSME consulting firm in Ludhiana that builds sales, operations, HR and costing systems for manufacturers, traders and service businesses across North India. About TBS