Some advice ages well. And some advice doesn’t really check out in the real world.
What is manufacturing accounting?
Manufacturing accounting focuses on the costs incurred during the production of goods. It includes inventory valuation, calculating the cost of goods manufactured (COGM) and cost of goods sold (COGS).
But in manufacturing accounting, there are some things that are just more fake than fact. Or at the very least, worth a good, hard look.
First some important manufacturing definitions:
Cost Allocation
Cost allocation in manufacturing accounting involves attributing the various expenses like raw materials, to the right finished product.
Inventory Valuation
Inventory is found on your balance sheet, so it’s important to value it properly. Manufacturers usually have three types: raw materials, finished goods and works in progress. For each type of inventory, two factors impact inventory valuation: the physical count of items and their value.
Overhead Allocation
Overhead is a term to describe indirect costs such as rent, insurance and taxes, supporting labor and supplies (and other small components) used to make products.
These are three things the manufacturing world treats as gospel that I’d give a second look. Call it my manufacturing myth-busters:
Myth #1: Maintain an inventory backlog for better warehouse workflow
The logic sounds reasonable. Keep a small buffer of unfulfilled orders so your team always has something to work on. No idle time.
Why is it prescribed as best practice:
“Why is deliberately holding back on fulfilling customer orders recommended?”
The AI answer:
- Smooths workflow
- Prevents idleness
- Absorbs variability
But none of those contribute to your bottom line.
You have customers waiting. Cash sitting on the other side of that shipment. And the response is to pump the brakes because the team is paid regardless??
The problem:
The buffer doesn’t protect your team. It slows your cash conversion cycle, creates potential problems with customers who are either used to, or go looking for, faster alternatives, and puts you at risk of losing orders to whoever will just ship the damn thing.
Long term, the backlog buffer could hurt more than help.
Myth #2: Allocating overhead into unit costs is the law
This one is taught in every cost accounting class, so let me be careful about how I say it.
Traditional cost accounting tells you to allocate overhead into each unit you make.
Rent, utilities, management time: spread them across your product costs so each item “carries its share.” The idea is that you get a “fully-loaded” cost per unit.
Why is this taught?
“Why is it taught to allocate overhead into unit costs?”
The AI answer:
- Financial Reporting: GAAP require companies to include a fair share of overhead in inventory values on balance sheets.
- Product Pricing: Managers need total unit costs to set selling prices that cover all factory expenses and secure profits.
- Cost Control: Tracking overhead helps find areas of high spending and waste within a business.
- Profit Analysis: It shows which specific items or services make money and which ones lose money.
The problem:
Fixed costs don’t change with volume. That’s what makes them fixed. And it distorts your profit margin by item.
Quick example: You pay $10,000 a month in rent. You make 10,000 units. Traditional cost accounting says each unit carries $1 in rent cost. Makes sense.
Now a large customer comes in with an order for 5,000 units on top of your 10,000. The price looks thin on a fully-loaded basis. Your cost accounting model says the margin is… marginal. The deal looks borderline.
But wait.
You’re paying that $10,000 in rent whether you make 10,000 units or 15,000. Rent doesn’t go up. Which means that incremental order has basically zero overhead cost assigned to it in reality. It’s contribution margin that drops straight to your bottom line.
Allocating fixed overhead into unit costs makes sense for certain reporting purposes. But it can’t drive volume decisions. High-volume, lower-margin orders often look worse than they are. And lean months look more profitable per unit than the P&L tells.
Know the difference between your fully-loaded cost and your contribution margin. Both numbers matter. Knowing which one to use when is what separates good pricing decisions from expensive ones.
Related Read: Margin compression mistakes to avoid
Manufacturing Accounting Myth #3: Running your own fulfillment operation saves you per-order cost
Why in-house vs. 3PL?
The math is usually sold to me like this: A 3PL charges $5 per order. Your in-house team costs $3 per order. You ship 10,000 orders a month. That’s $20,000 in savings. Easy call.
Except you did the math wrong.
The problem:
The in-house model comes with a set of costs the per-order comparison ignores entirely.
- Fixed warehouse rent you pay whether volume is up or down.
- Full-time labor you carry through any seasonality.
- Equipment, racking and maintenance.
- HR overhead from managing a warehouse team.
- The opportunity cost of management time spent on logistics instead of the core business.
The 3PL model does look more expensive per transaction. But the cost is variable.
Because a 3PL typically charges a per-transaction fee along with your monthly standard fee, you don’t pay as much when you don’t need to.
When volume drops, your cost drops. When you need to scale quickly, you scale without a hiring cycle. And you’re not signing a 5-year lease on 20,000 square feet of space based on a volume projection that may or may not hold.
The wrong take here is that your per-order savings calculation treats fixed costs as if they disappear.
Fixed costs vs. variable costs: What manufacturers need to know
In this case, do run the full loaded cost. Warehouse rent, fully-burdened labor including benefits, equipment, management time. Divide by actual units shipped including slow months, not the peak volume you’re staffed for.
For a lot of manufacturers, the number is closer to 3PL pricing than you might think, and might even flip your decision completely.
expand your insight
Listen, none of these 3 are blanket rules that are always wrong. There are businesses where a backlog buffer makes sense, where fully-loaded costing is the right move, where in-house fulfillment genuinely wins the economics.
But they are often assumed to be the best manufacturing accounting moves when it just isn’t always true. I’d even call… bullsh*t.
Run the math specific to your business. Run it all the way through. Or ask us to do it for you. It’s kinda what we do at expandCFO.
Learn more about expandCFO’s NetSuite accounting for manufacturing >
