Best Practices in Food Processing: Standard Costs - The Blytheco Blog

Best Practices in Food Processing: Standard Costs

How can managing production costs improve food processing efficiency and profitability?

It’s been all over the news… food costs are going up! And if you are in the food processing or manufacturing business, that means higher ingredient costs and more pressure on margins.

So, how is this going to affect your company? As both a consultant and an operator in the food manufacturing business for many years, I have often found that food companies, particularly smaller and family- owned businesses, don’t fully understand the many component parts of product costs. Ingredients are one thing, but there is also packaging, labor, rent, utilities, regulatory fees, administration, etc., etc. Knowing how each cost center contributes to aggregate product cost is critical to your business … but even more so is the ability to track these component parts and manage them effectively.

Typically, product costs are made up of three major categories:

  • Ingredients and Packaging – Take a specific food item, like a sauce, a loaf of bread, an entrée… whatever it is you manufacture. You can easily determine the actual cost of each of the ingredients and the packaging materials used in a batch or recipe by multiplying the number of units used by the unit cost. But, how do you maintain accuracy when costs change, up or down, as often as every time you re-order?
  • Labor – Direct labor is also readily determined and assigned. And this is easy when you use the same people every day. What if there is are overtime, equipment downtime, or scheduling issues.? If you don’t take the time to recalculate, accuracy can suffer.
  • Overhead – The “black hole” of cost management in most operations. This is where most accountants put the rent, the utilities, indirect labor, professional fees… all sorts of costs that are hard to quantify and assign to individual products. How do you know if you have assigned enough coverage for these costs to each of your products?
  • As you can see, it is difficult to identify and accurately track all of the costs of making your food products. In my view, one of best solutions to managing this problem is to use Standard Cost Accounting.

    What if, instead of assigning actual costs to a manufactured food item, we use an estimate of what we think the individual costs are going to be? This estimated cost, or “standard cost” will normally be set once per year, typically when you develop your annual budget . The standard cost can be used in many ways… , most often in developing inventory value and costs of goods sold. You still have to pay the actual costs when the bills come due, and there will almost always be a difference between the standard cost and the actual cost. These differences are called variances.

    By establishing a standard cost and tracking the variances from actual costs, you now have a valuable management tool. As variances are reported, your team can be informed of where costs differed from the expected costs and to what degree. Unfavorable variances indicate actual costs are higher than planned and steps can be taken to determine both the cause and possible solutions. Favorable variances indicate that resources that were allocated to a specific product were overestimated and either unnecessary, or available for use elsewhere. The sooner these variances are recorded and reported to management, the sooner the operation can be tweaked to better comply with your budget and financial goals.

    If you have or plan to deploy Enterprise Resource Planning (ERP) software, you are in luck. Standard costing is an accounting and management tool offered by almost all ERP software packages. This approach allows you to establish a product cost benchmark and then measure performance against that benchmark over a set period of time. This can be done by batch, production run, daily, weekly, or at whatever interval you desire.

    Managing costs, tracking inventory, ensuring quality – all mission-critical functions for food processors. How effectively is your ERP system helping you manage all facets of your production and operations? Take a short quiz to get a grade on your current system.

    Michael Siegmund

    About the Author: Michael Siegmund is Supply Chain Executive at Winslow Bainbridge Consulting, former President of RM Foods, former Director of International Supply Chain at Starbucks Coffee. Thoughout the “Traceability and Beyond” blog series, Mr. Siegmund will be sharing with us “Best Practices in Food Processing,” tips for Processors to improve efficiency throughout their business lifecycle.

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