How to calculate cost of production with a bill of materials

What is cost of production?

Cost of production is what it costs you to turn raw materials into one finished unit: the materials used, the material lost as scrap, and the labour and overhead spent on the batch. It is the number every selling price, discount and margin report depends on.

Without a written recipe, the number lives in the owner's head and drifts as prices change. A bill of materials (BOM) writes the recipe down once, so anyone can recalculate the cost in a minute when steel or paint gets dearer.

What goes into a bill of materials?

A bill of materials lists what one batch of a finished product consumes and how many finished units that batch makes. Four terms do all the work:

• Output quantity: how many finished units one batch of the BOM produces, for example 10 chairs.
• Component quantity: how much of each raw material the batch needs if nothing is wasted, for example 40 metres of tube.
• Scrap percent: the extra share of a component lost in cutting, bending, spraying or rejects. It is set per line, because tube offcuts and paint overspray are not the same.
• Additional cost: labour, power and other overhead for the batch, entered as one amount per batch rather than per unit.

What is the formula for cost of production per unit?

Cost of production per unit is total batch cost divided by output quantity, where total batch cost is material cost with scrap plus additional cost. It takes three steps:

The average cost is the weighted average cost of each component in stock today. If you have not read how that average moves with every purchase, weighted average cost explained walks through it.

How do you cost a steel chair from its BOM?

Here is the BOM for the steel visitor chair at Lakshmi Steel Furnitures, the fictional Coimbatore business used across this site. One batch makes 10 chairs. Tube and paint carry scrap; the bought-in parts do not.

Check two lines by hand. Tube: 40 × 1.05 = 42 metres, and 42 × ₹62 = ₹2,604. Paint: 2 × 1.10 = 2.2 kg, and 2.2 × ₹380 = ₹836. Leave scrap out and the material cost falls to ₹5,770, so every chair looks ₹20 cheaper than it really is.

₹747 is the standard cost: what a chair should cost at today's average prices if the batch runs as planned. It is the figure to price from and to compare against what actually happened.

Why does actual cost differ from standard cost?

Actual cost differs from standard cost because components are valued at their average cost on the day the work order is completed, and that average moves with every purchase in between. The recipe stays the same; the prices do not.

Say Lakshmi Steel opens a work order for 10 chairs. Before the work order is completed, a new bill for tube comes in at a higher price and the tube average rises to ₹66 per metre. A cheaper paint purchase pulls the paint average down to ₹370 per kg.

The finished chairs enter stock at the actual figure, ₹761.60 each, not at the standard. That is what makes the stock value and cost of goods sold honest. The ₹14.60 gap is a signal, not an error: tube costs more now, and your price list may need to follow.

Other common reasons for a gap are scrap running higher than the BOM assumes, or labour and power for the batch costing more than the additional cost on the BOM. When the same gap shows up batch after batch, fix the BOM rather than living with it.

How do you set a selling price from cost of production?

Set a price from cost by choosing either a markup on cost or a margin on price, and never mixing the two. A 25% markup and a 25% margin are not the same price.

• Markup is profit as a share of cost: price = cost × (1 + markup%).
• Margin is profit as a share of the selling price: price = cost ÷ (1 − margin%).

Price from the standard cost, then watch the actual cost on each completed work order. If actual cost keeps running above standard, your real margin is thinner than the table says.

How do you keep cost of production accurate?

A BOM is only as accurate as the quantities, scrap and prices behind it. Run through this list whenever you add a product or change a supplier:

• Measure component quantities from a real batch, not from a drawing
• Set scrap per line from what the bin actually collects over a few batches
• Enter every purchase with its real cost, so the average cost behind the BOM is current
• Include labour, power and job-work charges in the additional cost for the batch
• Compare actual cost with standard cost on every completed work order
• Raise a new BOM version when the recipe changes, instead of editing history
• Review selling prices when the standard cost moves by more than you can absorb

As of October 2026, the accounting standards on inventories (AS 2, and Ind AS 2 for companies that follow it) value finished goods at cost including materials and conversion costs such as labour and production overhead; your accountant decides which overheads belong in stock value.

How does SimpleERP calculate cost of production?

SimpleERP keeps a bill of materials per finished product, with versions, an output quantity, scrap percent per line and an additional cost per batch. The cost roll-up is live: it uses the formula above with each component's current weighted average cost, so the standard cost per unit updates as purchases post.

• A work order snapshots the BOM, so later edits do not change a job already planned.
• Completing the work order takes the materials out of stock at their average cost and posts the entries in one step.
• Each work order has one completion, and the finished goods enter stock at actual cost.
• A completed work order cannot be edited or cancelled; a correction goes through a stock adjustment with a reason.

For how a work order moves from plan to finished goods, read work orders for small factories. For the module itself, see manufacturing, and for the wider stock picture, the inventory management guide.