Direct Material Cost
Direct material cost is the expense that a company incurs to purchase or produce the raw materials that are directly used in the creation of its goods or services. These are materials that can be directly traced back to the finished product.
For example, in a car manufacturing company, the costs of steel, glass, tires, etc., used in the production of the car would be considered direct material costs. Similarly, in a bakery, the cost of flour, sugar, eggs, and any other ingredients used in the baking process would be direct material costs.
The direct material cost is a crucial component of the total production cost, which also includes direct labor cost and manufacturing overhead. It’s an essential part of cost accounting and plays a significant role in pricing decisions, profitability analysis, and financial planning in a company.
Direct material costs are considered variable costs, as they change in direct proportion to the volume of goods produced: the more goods you produce, the higher your direct material cost will be, and vice versa.
Example of Direct Material Cost
Let’s use the example of a company that manufactures wooden tables.
- Material Requirement per Table: Suppose the company needs 20 feet of lumber to manufacture a single table.
- Cost of Lumber: The cost of the lumber is $5 per foot.
Given these two pieces of information, we can calculate the direct material cost per table:
Direct Material Cost = Material Requirement per Table * Cost of Lumber
Direct Material Cost = 20 feet * $5/foot
Direct Material Cost = $100
So, for each table that the company produces, it incurs a direct material cost of $100.
Now, suppose the company plans to manufacture 500 tables in a particular month. The total direct material cost for that month would be:
Total Direct Material Cost = Number of Tables * Direct Material Cost per Table
Total Direct Material Cost = 500 tables * $100/table
Total Direct Material Cost = $50,000
Therefore, the company would need to budget $50,000 for direct materials (lumber) for that month to meet its production goals. This calculation helps the company plan its finances and make decisions about pricing, profitability, and production volumes.