Understanding the difference between standard cost vs actual cost is vital for your manufacturing business’s success in today’s competitive market. Even though standard cost and actual cost are important in accounting, their applications, calculations, and impacts on financial performance are different and impact all departments.
In this article, we’ll explain the difference between standard cost vs actual cost, how to calculate standard cost and actual cost, and how to use each one in a practical setting. We’ll also explain how IoT solutions can automate the data collection and cost analysis needed to improve profitability for manufacturers.
Standard Cost vs Actual Cost: What’s the Difference?
There are key differences between standard cost and actual cost that are especially important for manufacturing businesses. While your accounting team may prefer to use actual cost at the end of the day, there are reasons and use cases for both.
Standard Cost: Definition, Uses, Types, and Calculation
The definition of standard cost in manufacturing is the predetermined cost of manufacturing a product or providing a service, based on the cost of materials, labor, and overhead.
We recommend manufacturing businesses use standard cost as a benchmark against which actual costs can be compared. In other words, use standard cost to plan, budget, forecast, and evaluate your financials.
When using standard cost, you’ll be looking at the (often fluctuating) prices of materials, labor, and overall overhead. Because of this, your financial management team isn’t the only department that needs to contribute to assessing standard costs.
Other departments that should be offering input on standard costs include:
- Human resources to ensure they are hiring within predetermined salary bands.
- Procurement will have data on past costs of raw materials.
- Supply chain management will be able to offer insights and forecasts regarding any kind of supply chain disruption and potential trends of rising prices.
Ask for feedback from key stakeholders to create the most accurate and realistic benchmarks for the coming month, quarter, and year.
Finally, you can calculate standard cost by multiplying the standard quantity of hours of inputs, meaning materials, labor, and overhead, by the standard rate or price per unit of input.
Actual Cost: Definition, Uses, Types, and Calculation
While standard cost is a prediction of future costs based on historical data and industry trends, actual cost is different.
Actual cost is defined by the real costs incurred when you manufacture a product or offer a service. It’s determined after the manufacturing and distribution process is complete based on what was actually spent on materials, labor, and overhead.
We recommend our clients use actual cost to evaluate the financial performance of your manufacturing operations. By comparing your actual costs to your standard costs, you can identify areas where your business overspent or where it can save money. These differences between actual cost and standard cost are called manufacturing variances.
You can calculate actual cost by adding up the actual expenses for materials, labor, and overhead incurred during a specific time period, like the previous month, quarter, or year, or by production run.
How to Use Standard Cost vs Actual Cost to Increase Profits Using the Industrial Internet of Things (IIoT)
In Industry 4.0, if you’re not using smart technology like IoT devices, you’re falling behind your competitors.
IoT can play a significant role in increasing profits for manufacturers by leveraging standard cost vs actual cost analysis. Here’s how IoT can be integrated into your cost management strategies to increase profits.
Collect and Monitor Data in Real Time
Whether you purchase machinery that comes equipped with smart technology or you add IoT devices to older equipment, you will benefit from real-time, accurate data collection. IoT devices like sensors, RFID tags, and programmable logic controllers (PLCs) continuously acquire data on many aspects of production, like material usage, machine performance, energy consumption, and labor efficiency.
The benefit of constant accurate data collection is that you don’t have to wait until the end of the month, quarter, or year to identify deviations in actual costs from standard costs. For example, your IoT system can alert you if there’s a sudden variance in the consumption of energy from a machine. This could mean it’s time for machine maintenance due to a leak, or that employees are not using the equipment correctly.
It’s crucial to address these problems as soon as possible, and IoT makes that possible.
Stop Wasting Money on Routine Maintenance
With IoT technology, you can switch from routine machine maintenance to predictive maintenance.
Predictive maintenance is when a business utilized IoT devices to measure machine performance. This removes the guesswork needed to identify problems with machinery as well as the cost of having technicians come out when they’re not actually needed.
You can essentially remove the cost of routine maintenance from your standard costs and add the estimated cost of predictive maintenance instead, which tends to be much less, depending on the age and use of your machinery.
Ensure a Productive Workforce
IoT solutions like ProphecyIoT can track and analyze workforce productivity key performance indicators (KPIs). IoT devices can collect data around machine uptime, production output per hour, and labor utilization rates.
By using this data in combination with comparing actual cost vs standard cost, your business can identify areas for improvement and optimize workflows to increase efficiency. This will help you reduce labor costs and improve overall performance.
Manage Inventory Like a Boss
Inventory management is among the most complex and costly tasks in manufacturing. This is where many of our clients see their largest manufacturing variances.
IoT can assist in a variety of inventory reduction strategies to help your team make sure it has just enough inventory without the risk of stockouts.
For example, an IoT-based tracking system offers real-time visibility into inventory levels, warehouse location, and movement. These technologies help businesses control material costs more effectively and avoid overstocking, which can lead to wasteful inventory carrying costs.
Data Analytics and Cost Analysis
The wealth of data collected by IoT devices, combined with advanced analytics and cost analysis tools that come with IoT and enterprise resource planning (ERP) systems, help your team perform in-depth cost comparisons between standard costs and actual costs.
Detailed manufacturing variance analysis help manufacturers find cost-saving opportunities as well as ways to allocate resources more responsibly. On top of that, your team can make smarter, data-backed decisions that help increase profitability.
Leverage IoT for Top-Tier Standard Cost vs Actual Cost Analysis
IoT technologies work seamlessly with standard cost vs actual cost analysis, allowing manufacturers like you to enhance cost visibility, improve operational efficiency, lower expenses, and increase profits.
At ProphecyIoT, we’ve helped manufacturers deploy IoT solutions to great effect. Using real-time monitoring, advanced data collection and analysis, predictive insights, and more accurate forecasting, your business can achieve greater cost control and competitiveness, regardless of your industry. Contact us today to learn more.
