Material cost refers to the cost of materials used in the production of goods or the provision of services. It is an essential component of the total cost of a product and includes costs associated with procuring, storing, and using the raw materials. Material cost is often subdivided into direct and indirect materials cost.
- Direct Material Costs: These are the costs of raw materials or parts that go directly into the production of the product. For example, the cost of wood used to make a table or the cost of fabric used to make a dress would be considered direct material costs. These costs can be directly attributed to a specific product.
- Indirect Material Costs: These are the costs of materials that are used in the production process but are not directly part of the final product or cannot be conveniently traced back to it. These might include things like cleaning supplies used in the manufacturing plant or oil used for machine maintenance. Indirect materials are often considered part of manufacturing overhead.
The material cost is a significant part of a company’s cost structure and directly impacts the profitability and pricing strategies of the business. Lowering material costs (through strategic sourcing, bulk purchasing, or other efficiencies) can lead to increased profitability, assuming all other factors remain constant.
Example of Material Cost
Let’s use the example of a furniture manufacturing company called “Woodcraft Furniture.”
- Direct Material Costs: Suppose Woodcraft Furniture manufactures wooden tables. The direct material costs would include the cost of wood, nails, screws, glue, varnish, etc., which are directly used in making the tables. If the cost of wood for each table is $50, nails and screws are $5, and glue and varnish cost $10, then the total direct material cost per table would be $65.
- Indirect Material Costs: These could include materials used in the production process that aren’t part of the final product. For example, cleaning supplies for the manufacturing facility, lubricants for machines, or even small tools used in the process could be part of the indirect material costs. Let’s say these indirect materials sum up to $2000 per month. If Woodcraft Furniture produces 200 tables a month, then the indirect material cost allocated to each table would be $10 ($2000/200 tables).
So, the total material cost per table, combining both direct and indirect costs, would be $75 ($65 direct + $10 indirect).
Remember, this is a simplified example. In actual business scenarios, the calculation of material costs could be much more complex and would need to take into account things like waste, scrap, price fluctuations of materials, etc.