# How is BOM cost calculated?

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## Introduction

The bill of materials (BOM) is a critical component of manufacturing that lists all the parts and components needed to build a product. The total cost of the BOM determines the direct production costs for the product and has a large impact on the final pricing. Therefore, accurately calculating BOM costs is essential for manufacturers to understand profitability and make sound business decisions when bringing a product to market.

This article provides a comprehensive overview of how BOM cost is calculated for electronic and technical products. We’ll examine the factors involved in estimating the costs of material items, component pricing considerations, handling overhead expenses, and best practices for optimizing BOM cost analysis.

## What is a bill of materials (BOM)?

A bill of materials is a structured list of all the parts and components that go into manufacturing a particular product. The BOM details the materials required to assemble each higher level component, subsystem, and ultimately the finished product itself.

For electronic products, the BOM encompasses:

• Active componentsIntegrated circuits, transistors, diodes, LEDs, etc.
• Passive components – Resistors, capacitors, inductors, transformers, etc.
• Electromechanical parts – Connectors, switches, sensors, motors, etc.
• PCBs – Bare printed circuit boards and assemblies.
• Miscellaneous – Hardware, terminals, standoffs, fasteners, wiring, etc.

The BOM is much more than just a parts list. It also provides key information needed for costing analysis including:

• Part numbers – Unique identifiers for each item
• Descriptions – Details on the specific component
• Quantities – How many of each item are required
• Manufacturers – Vendor source for procuring each item
• Unit pricing – Cost per item (a key input to total BOM costing)

## Why BOM costing matters

Calculating an accurate BOM cost is critical for several reasons:

• Determines production costs – The total BOM cost largely defines the direct manufacturing costs to build the product.
• Enables accurate pricing – Pricing to distributors or end customers must cover total production costs plus margin. Undercosting the BOM results in losing money.
• Aids sourcing decisions – Understanding material costs helps assess different supplier options during procurement and contracting.
• Allows cost reduction – Detailed BOM analysis identifies opportunities to reduce costs through part substitution, design changes, different vendors, etc.
• Supports cost tracking – BOM cost models provide the baseline for monitoring actual material costs as production ramps up.
• Identifies cost risks – High cost items or uncertain estimates are visible for contingency planning or management attention.

In summary, solid BOM cost knowledge is required to make sound financial decisions as a product transitions from design to mass production. Both upfront accuracy and continuous cost management relies on robust BOM costing mechanisms.

## BOM cost components

Several elements comprise the total cost calculated for a bill of materials. These include:

Component costs – The per unit prices for the raw materials, parts, and assemblies used to build the product. This constitutes the majority of the total BOM cost.

Labor costs – The labor expense (direct wages and benefits) required for assembly, soldering, insertion, finishing, testing, inspection, and other handling of components during production.

Tooling/fixture costs – Expenditures for production tooling like PCB assembly jigs, molds, or dies used to assemble or form parts of the product. These fixed costs are often amortized over the total production volume.

Allocation of overhead – A share of production overhead costs like facilities, utilities, management, quality, logistics, equipment maintenance, etc. is allocated to each product BOM based on its utilization of resources.

Margin – An additional markup percentage is added to cover non-production costs and ultimately provide profit margin. This markup structured depends on the company’s business model and cost management strategies.

The details of these cost elements will vary for different manufacturing environments, but together they comprise the full calculation of a product’s bill of materials cost.

## Estimating component costs

The prices paid for the thousands of specific parts and materials that make up the BOM have the biggest influence on its total cost. Several techniques are used to estimate component costs:

Historical data – Costs paid in the past for the same or similar parts provides a good starting point estimate, adjusted for any known price trends.

Supplier quotes – Contacting component vendors and getting current price quotes on the required volumes delivers highly accurate estimates.

Industry data – Published electronic component price indexes and reports provide guidance on pricing trends for different commodities.

Parametric models – Cost models based on technical attributes like part type, tolerance, rating, and packaging can estimate costs when no direct data is available.

Design data – Information on required materials and processing can provide rough estimates based on market prices for those material stocks or processes.

Comparable analysis – Sometimes component pricing is estimated by comparison to another part of known price with similar attributes.

In most cases, a combination of these techniques produces the most reliable component cost estimates, cross-checked against multiple sources. Detailed quotes from vendors should be used to finalize pricing for volume forecasts.

## Key variables in component pricing

Some of the key variables that affect the pricing of individual components include:

Component specifications – Higher temperature ratings, tighter tolerances, higher power capacities, etc. increase cost.

Materials used – Materials costs directly influence component costs, for example precious metals vs. commodity metals.

Packaging typeSurface mount vs. through-hole, trays vs. reels, etc. drive different costs.

Order volumes – Suppliers offer discounted pricing at higher order quantities due to lower per piece handling costs.

Market conditions – Component shortages, demand surges, commodity prices etc. impact market prices.

Geographic factors – Components sourced locally vs. overseas have different cost structures including import duties.

Company size – Large manufacturers get better pricing than smaller companies based on sheer order volume.

Lifecycle stage – End-of-life or obsolete components can have rapidly escalating prices as supplies diminish.

Careful consideration of these variables is necessary to develop accurate cost estimates, particularly for complex or custom components.

In addition to direct material costs, an allocated share of manufacturing overhead expenses is added to the BOM costs. This covers the infrastructure required to physically handle and process the materials into products.

Typical overhead costs charged to production include:

• Facility costs – Rent, utilities, property tax, insurance, maintenance, etc.
• Support labor – Supervisors, material handlers, quality inspectors, facilities staff, management
• Depreciation – Equipment, tools, information systems
• Supplies – Cleaning chemicals, lubricants, office items, small tools, etc.
• Logistics – Warehousing costs, inbound/outbound transportation

To allocate these overhead costs, manufacturers calculate a handling rate per hour or per unit based on the capacity utilization by each product. Higher usage drives more overhead allocation. Rates are based on budgets and activity-based costing models.

## Best practices for optimizing BOM costing

To achieve the most value from BOM costing analysis for making sound financial decisions, companies should follow these best practices:

• Involve sourcing/procurement early – Work with the team responsible for purchasing and supplier contracting during initial BOM analysis to get realistic pricing.
• Leverage design data – Work jointly with engineering teams to understand design factors that drive material selection and specifications to inform cost estimates.
• Use standard component classifications – Assign standard material categories or grades to each component to aid in consistent cost rollups.
• Perform risk analysis – Identify high cost components and items with uncertain or volatile pricing for management focus.
• Link to ERP/MRP systems – Integrate BOM data with enterprise systems used for inventory, orders, and production planning to enable seamless cost analysis.
• Regularly update for changes – Review component costs against quotes or market pricing continually throughout product lifecycles to maintain accuracy.
• Analyze cost reduction opportunities – Dig into detailed BOM data to find areas for reduced material usage, alternate components, or lower cost suppliers.
• Monitor and report actuals – Compare actual material costs booked during production to BOM forecasts to identify discrepancies and improve future estimates.
• Use software tools – Modern platforms like Arena and FactoryLogix offer robust BOM cost management capabilities to eliminate spreadsheets.

By following these guidelines, organizations gain tremendous visibility into product cost structures and drivers. This allows smart decisions on pricing, sourcing, investments, and product direction to ultimately maximize profitability.

## BOM Costing Case Study

Here is an example demonstrating real-world application of BOM costing analysis:

Acme Electronics was preparing to launch a new wireless security camera product for the consumer market. Engineering provided the BOM with 250 different components sourced from a mix of global suppliers.

The operations team imported the BOM data into the company’s cost management platform. Component costs were estimated using market price benchmarks and supplier quotes where available. Overhead rates were applied based on production line utilization.

The full analysis showed a total BOM cost of \$42 per unit in 10k unit volumes. However the team identified two very high cost image processing ICs driving 15% of the total cost. A design change was approved to replace these with a lower cost standard part, dropping the BOM to \$38.

This enabled Acme to reduce the retail price from \$99 to \$89 while maintaining margins. At an anticipated 100k unit volume over 2 years, the \$11 reduction results in \$1.1M additional profit. This demonstrates the power of detailed BOM analysis to impact the bottom line.

## Conclusion

Performing robust and accurate bill of materials costing provides manufacturers critical insights into product profitability as they prepare to ramp from design into production. By following structured cost estimation approaches and continuous analysis best practices, companies make fully informed supply chain, pricing, and new product decisions.

Well managed BOM cost processes link design, procurement, finance, and operations functions to optimize production costs. As product complexities increase, capable BOM software tools deliver the modeling flexibility and rapid analysis required to maximize earnings in competitive markets. With proactive cost focus starting early in development, firms can accelerate new product introduction while ensuring each product delivers against financial targets.

## FQA on BOM Costing

### What are some warning signs of inaccurate BOM cost estimates?

Indicators of potential errors in BOM estimates include:

• Component pricing outliers deviating widely from industry norms or experience
• Excessive usage of “guesstimates” rather than actual data
• Labor/overhead rates inconsistent with accounting records
• Frequent large discrepancies between estimates and actual costs
• Lack of supporting documentation for pricing assumptions
• Minimal involvement from procurement/sourcing teams
• Using old estimates without updating for current prices

### What data sources provide the most accurate component pricing information?

The pricing data hierarchy from most to least accurate includes:

• Direct supplier quotes based on required volumes
• Recent purchasing history for the same components and volumes
• Sourcing team market research and negotiated contracts
• Published market pricing indexes validated by multiple sources
• Parametric models based on technical attributes like materials, tolerances, packaging, etc.
• Rough estimates by engineers based on specifications and materials

### What are some common strategies used to reduce BOM costs?

Tactics to lower BOM costs include:

• Consolidating designs to use fewer component variants
• Negotiating lower component prices based on higher volumes
• Choosing suppliers with lower cost structures
• Adjusting designs to reduce quantity requirements through strategies like component sharing
• Targeting high cost components for redesign or substitution
• Identifying and eliminating unnecessary requirements driving overspecification
• Value engineering reviews to simplify or streamline product architectures

### What problems can inaccurate BOM costs cause during production?

Underestimating component prices leads to negative margins once in volume production. Overestimating BOM costs causes inflated pricing that can result in lost sales compared to the competition. Both outcomes lead to financial losses and potential product failures in the market.

### How should BOM cost estimates be documented for future analysis?

BOM estimates should capture details like:

• Reference sources for all component pricing like quotes, indexes, models, etc.
• Assumptions on volumes ordered for each component
• Allowances made for rises in future component prices
• Basis for overhead rates applied and allocation methodology
• Contingencies included for high risk or uncertain cost items
• Descriptions of any product redesign iterations impacting the BOM

This documentation enables future review of the logic behind estimates.