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What is Direct Materials
In a typical manufacturing process, it’s important to understand the cost of ingredients or components. That’s why in the manufacturing world, these ingredients are referred to as "raw materials” or direct materials.
But how can Shopify brands measure and understand the cost associated with these materials? That’s what we get to learn from the direct materials used formula and related calculations in a simple-to-understand way.
Formula for Direct Raw Materials
The Direct Material Cost Formula is pretty straightforward. You need to start with the amount of materials you had at the beginning of a period called Beginning Inventory. Then you need to add purchases made during that period and subtract the materials left over at the end, i.e., Ending Inventory.
This calculation provides you with the total amount of Direct Materials utilised in your production.
It calculates the total cost of materials actually used in producing goods. Jumping straight into the exact formula:
Direct Material Cost = Beginning Inventory + Purchases during the period - Ending Inventory
Consider an apparel store on Shopify that begins the month with $10,000 worth of fabrics and other materials as its Beginning Inventory. During the month, it purchases an additional $7,000 worth of materials. By month's end, the store has $4,000 worth of materials left as Ending Inventory.
Using the Direct Material Cost Formula:
Direct Material Cost = $10,000 (Beginning Inventory) + $7,000 (Purchases during the period) - $4,000 (Ending Inventory) Direct Material Cost = $13,000
This calculation reveals that the apparel store used $13,000 worth of materials in crafting its products throughout the month. Such calculations are generally done automatically in the best clothing inventory management tools and software.
This formula helps businesses understand the actual cost of materials consumed in the production process.
Interpreting the Value for Direct Materials Used & Applying For Your Brand
Understand & apply the Direct Raw Materials Used Formula allows a company to accurately track the cost associated with the production materials.
This information is helpful for:
- Knowing exact cost of raw materials used in production helps in setting up product prices.
- Budgeting: Predicting future raw material requirements and their costs.
- Assessing the raw material cost components as part of an overall inventory management strategy.
Prediko simplifies this calculation for Shopify D2C Brands
Prediko's Raw Material Planner allows you to set up or import your raw materials as well as your bill of materials (BOM) into Prediko within minutes.
Once your raw materials and BOM are uploaded, you can then create production orders that contain those raw materials and sent them to your suppliers.
Prediko tracks the usage of raw materials in production dynamically as you create production orders within the system and gives you alerts on when you need to reorder which raw materials to guarantee continued finished good production. We have also written a detailed guide on how to start with raw materials inventory management.
Three Methods to Calculate Direct Material Cost: FIFO, LIFO & Weighted Average
Beyond simply calculating direct material costs, businesses can apply different inventory valuation methods to track the cost of raw materials consumed. The three common approaches are:
1. FIFO (First-In, First-Out)
Under the FIFO method, the earliest (oldest) inventory purchased is used first. This means that raw materials bought first are the first ones to be consumed in production.
- Best for: Businesses that want to ensure older stock is used first, reducing waste and aligning with natural inventory flow.
- Example: If a Shopify brand purchases 100 units at $5 each and later buys 100 units at $7 each, FIFO assigns the cost of production based on the older $5 units before using the $7 ones.
Learn how to use the FIFO method for inventory management.
2. LIFO (Last-In, First-Out)
Under LIFO, the most recently purchased inventory is used first, meaning the newer stock gets used up before the older stock.
- Best for: Businesses operating in inflationary markets where prices rise over time. LIFO results in higher costs, reducing taxable income.
- Example: If the latest batch of materials cost $7 per unit and the older batch cost $5 per unit, LIFO assumes the $7 materials are used first, increasing the cost of goods sold (COGS).
Learn how to use the LIFO method for inventory management
3. Weighted Average Cost (WAC)
The Weighted Average Cost method calculates a new average cost per unit after each purchase, distributing the total cost of materials evenly across inventory.
- Best for: Businesses looking for a simple and consistent valuation method, especially when prices fluctuate.
- Example: If a brand purchases 100 units at $5 each and another 100 units at $7 each, the WAC per unit would be:
- ($5 × 100 + $7 × 100) ÷ 200 = $6 per unit
Each unit is then valued at $6, balancing cost fluctuations over time.
Why Does This Matter?
Choosing the right method impacts:
- Profitability: LIFO increases cost of goods sold (COGS) in times of rising prices, reducing taxable income, while FIFO lowers COGS, boosting profits.
- Tax implications: Different accounting rules apply to each method, so Shopify brands must ensure they comply with tax regulations.
- Inventory strategy: FIFO helps maintain fresh stock, while LIFO may be beneficial in certain cost-cutting strategies.
See how Leading eCommerce brands mastered their Shopify inventory with Prediko,
- Healf Achieved 75x ROI by Reducing Stockout
- How Obsidian Piercing Increased Best Seller Revenue by 200%
- How Kate Hewko boosted Inventory Efficiency by 40%
