This section is from the "Modern Machine Shop Construction, Equipment, And Management" book, by Oscar E. Perrigo. Also see Amazon: Modern Machine Shop Construction, Equipment, And Management.
It is certain that men will make mistakes in judgment of business conditions and that losses will ensue. But not more in manufacturing enterprises than in any other line of business. The stock broker, for instance, conducts a business with much more liability to loss through depreciation, as well as from other conditions, but his accountant does not enter securities at their forced sale value.
Therefore it seems fair to consider the manufacturing plant in the light of a live, going concern, with the usual prospects for good business. Its Operations are directed by a man who possesses a natural ability for judging commercial opportunities and business conditions, and at least a fair amount of appreciation of the value and excellence of good original designing as well as of the fact that the development and evolution of mechanical operations require the adoption of improvements from time to time in order to keep pace with legitimate competition.
Adopting this view we find that the overhead charges will consist of three factors, which may be summed up as follows:
Fixed Charges, covering interest upon the cost of the land, buildings, fixtures, power, lighting, heating, and transportation plants; insurance, taxes, water rates, etc.; the cost of maintenance and the depreciation of valuation.
The Expense Burden, including the cost of so-called non-productive labor, cost of lighting, heating, ventilating, cleaning, transporting material, the interest upon the cost and installation, and the depreciation charge upon machines.
The Supplemental Burden will be the cost of the temporarily idle machines, which, with the exception of the cost of power, cost as much as when working at full efficiency upon useful product.
The Overhead Burden will be the sum of the above three accounts, although the method of bringing them into the burden account varies with their individual characteristics.
Our problem is the proper apportioning of these charges to the Flat Cost of the product. What is the flat cost of the product? We may analyze the various factors and classify them as factors in manufacturing costs, in the following manner, without going back to the elementary accounts by which these factors are determined. The different classes of accounts or costs with which we have to deal will be:
The amounts paid for productive or direct labor, that is, labor applied directly to the product, whether for operations on a machine or by hand.
The expense of all material that goes directly into the product and becomes a part of it.
Overhead Burden, which is composed as above explained. There will also be the following accounts taken incidentally into the progressive arrangement that follows.
This will include the expenses of the general office, including salaries, interest, insurance, and maintenance of real estate, office fixtures, etc., and the cost of office supplies, including telegraph, telephone, express, postage, legal, traveling, and similar expenses; but not including any of these items in the sales department.
The same list of expenses as are given for the general office, to which are added the expenses for advertising, commissions, allowances, discounts and similar expenses incidental to marketing the product.
The Profit is such a percentage of the manufacturing cost as the management may determine and the state of the market may permit.
To apply these factors in their relative and progressive relations we will have: 1. The Flat Cost consists of: The Labor Cost, The Material Cost.
2. The Factory Cost consists of:
The Flat Cost, The Overhead Burden.
3. The Manufacturing Cost consists of:
The Factory Cost, The Administrative Expense.
4. The Market Price consists of:
The Manufacturing Cost, The Selling Expenses, The Profit. For ascertaining the proper relation between the flat cost and the overhead burden a number of well considered and practical plans have been proposed, all of them having some merits deserving careful consideration. The two principally used, with some variations to suit local and individual conditions, have been as follows:
By this method there is charged to each job or order a percentage of the total amount of overhead burden in proportion to the number of hours of direct or productive labor. This is found by dividing the total overhead burden by the total number of hours of productive labor worked for a given period, say three or six months, or a year, thus obtaining an hourly rate which may be added to each hour of productive labor on the job or order, in addition to the cost of material, to ascertain the flat cost of the job.
The plan is defective for the following reasons. It places all classes of labor, whether skilled or unskilled, and whether working with a few hand tools or with an expensive machine, on a level. By this method a job done largely on leadlines would not bear its fair share, while a job done by hand at the bench would be assessed with an amount far in excess of its proper burden.
Again, if two men receive the same wages, one of them operating a small lathe and the other a large planer, the burden charged for an hour's work would be the same for the small lathe as it would be for the large and expensive planer. In actual practice this problem will appear in this manner. Consider a job done on the small lathe
Machine rate ........................
15 cents per hour.
Wages of man ...................
40 cents per hour.
55 cents per hour or,
On a basis of 8 hours per day, $28.80.
In the case of the job done on the large planer:
45 cents per hour.
Man rate .........................
40 cents per hour.
85 cents per hour, or
On a basis of 8 hours per day, $40.80.
By the above "hourly plan," or averaging plan, each job would be charged on a basis of $19.20; one job would be charged $6. more than is equitable, while the other would be charged with $6. less than it should pay. The defects of the plan are thus glaringly apparent. Of course not all jobs will show as great a discrepancy as these, but the fallacy is only one of degree, and the principle will remain the same in all cases.