contract manufacturing

Uncover the steps involved in contract manufacturing, including raw material management and cost tracking. Discover how much you can achieve with the Microsoft Dynamics extension for contract manufacturing.

How Does Contract Manufacturing Work?

Contract Manufacturing Definition

Contract manufacturing involves a formal agreement where one company (the contractor) agrees to manufacture components or complete products for another company (the client). This arrangement allows the client to focus on other aspects of their business while leveraging the manufacturing expertise of the contractor.

Under this contract, the manufacturer produces a product on behalf of the company. This process streamlines production and allows companies to focus on their core competencies.

Components and Products

The client specifies the product they want to create. The contractor then produces either individual components (e.g., specific parts) or entire finished goods based on the client’s requirements.

Supply Chain Flexibility

Contract manufacturing provides flexibility. If the client lacks the resources or expertise to manufacture a product in-house, they can outsource it to a specialized manufacturer. This allows companies to compete in previously challenging areas.

Transparency and Collaboration are essential.

For successful contract manufacturing, transparency and collaboration are essential. The client and contractor work closely to ensure smooth production processes, cost-effectiveness, and adherence to quality standards.

Contract Manufacturing EPR for Microsoft Dynamics

We have developed an add-on Contract Manufacturing EPR for Microsoft Dynamics. This enhancement integrates with Microsoft Dynamics NAV, streamlining the contract manufacturing process. Here is a solution tailored to meet your manufacturing needs. We have the best ERP software for manufacturing applications whether you are using onsite Microsoft Dynamics NAV or cloud erp manufacturing.

Here are the key features:

  1. Determine production requirements (quantity) for finished goods items and create contract orders.

This initial step sets the stage for efficient contract manufacturing by defining the production needs and formalizing the collaboration through a contract order on the ERP for contract manufacturing.

Production Requirements (Quantity):

The first crucial step is to assess the production needs. Companies must determine the quantity of finished goods they require. This involves analyzing market demand, sales forecasts, and inventory levels.

Factors such as seasonality, lead times, and safety stock requirements influence the desired production quantity. Accurate demand forecasting ensures optimal resource allocation and prevents overproduction or shortages.

Creating the Contract Order

Once the production requirements are clear, companies create a contract order. This order outlines the specifics of the manufacturing arrangement.

Key details include the product description, quantity, delivery schedule, quality standards, and pricing terms.

The contract order serves as the formal agreement between the company and the contract manufacturer.

It ensures alignment between both parties and provides a foundation for successful production.

The solution helps determine the production quantity for finished goods. It facilitates creating contract orders based on demand.

  1. Raw Material Management

Raw materials needed for production are sent to the item vendor. These materials are maintained as inventory at the vendor’s location.

This step streamlines the production process by ensuring that the necessary raw materials are readily available at the vendor’s facility, ready for efficient finished goods production.

 Raw Material Identification

Companies identify the specific raw materials required for manufacturing the finished goods. These materials could include components, subassemblies, or any other inputs.

The raw materials are carefully selected based on product specifications and quality standards.

Inventory Management at the Vendor Location

Once the raw materials are identified, they are dispatched to the contract manufacturer’s location. The vendor maintains an inventory of these raw materials. This inventory is crucial for seamless production.

Inventory levels are monitored to ensure timely replenishment and prevent shortages.

Collaboration and Communication

Effective communication channels are established between the company and the vendor. This ensures transparency and coordination. The vendor provides regular updates on raw material availability, usage, and any potential issues.

Quality Control

The vendor conducts quality checks on incoming raw materials. This ensures that only approved materials are used in production. Non-conforming materials are flagged for corrective action.

Efficient Resource Utilization

By maintaining raw material inventory at the vendor’s location, companies optimize resource allocation. It reduces the need for storage space and handling logistics within the company’s premises.

  1. Post-Production Outputs

After manufacturing, the finished goods are posted to the item vendor. Again, raw materials remain part of the inventory at the vendor’s site.

Finished Goods Posting

Post finished goods in the inventory system for accurate tracking and accounting.

Select the appropriate warehouse, fill in header details, save, and then post the transaction.

Raw Materials Inventory Management

Raw materials are unprocessed materials used to create products.

Direct materials are components directly used in manufacturing, while indirect materials are supplementary items.

Effective raw material inventory management ensures smooth operations and cost efficiency.

Warehouse Inventory

Finished goods are received using a transfer order, updating the inventory at your warehouse.

  1. Vendor Invoices and Cost Tracking

Vendor invoices related to Labor and production costs are posted. These costs are added to the finished goods’ overall cost, impacting inventory valuation. steps for handling finished goods items using a transfer order to reflect finished goods item inventory at your warehouse:

  • Raw Material Quantities: Ensure you have raw materials in stock.
  • Create an Assembly Item/BOM: Define the finished good and its components.
  • Vendor Consigned Inventory: Set up a location for consigned inventory.
  • Vendor Bill for Shipping Charges: Capture shipping costs.
  • Transfer Order Creation: Transfer raw materials to the consigned inventory location.
  • Assembly Build: Receive finished goods via an assembly build.
  • Additional Vendor Bills: Add any additional charges.
  • Final Transfer: Move inventory from consigned inventory to the physical warehouse location.


  1. Posting a vendor invoice and accounting for the cost of labour/production in the context of finished goods inventory

Upon receiving the finished goods from the vendor, you’ll receive an invoice detailing the costs incurred during production. This invoice includes expenses related to labour, manufacturing, and any other associated charges.

Post the vendor invoice in your accounting system. Ensure that the relevant accounts (such as “Accounts Payable” or “Vendor Payables”) are updated with the cost information.

Cost of Labor/Production

The cost of labor and production directly impacts the overall cost of the finished goods.

This cost includes wages paid to workers involved in manufacturing, assembly, quality control, and any other production-related activities.

Additionally, it encompasses expenses related to machinery, utilities, and overhead costs.

Adding to Inventory Value

When you post the vendor invoice, the cost of labour/production is added to the inventory value of the finished goods.

This means that the total cost of the finished goods now includes both the raw material costs (previously accounted for) and the additional labour/production costs.

  1. Cost of Goods Sold

When the production item is sold, the cost of the finished good (including Labor and raw materials) is posted to the cost of Goods Sold(COGS) account. This accounting entry reflects the expenses directly associated with producing and delivering the sold item. The COGS account is crucial for calculating gross profit and assessing the profitability of your business. Remember to accurately record these transactions to maintain transparent financial records in your ERP module for manufacturing.


The contract manufacturing software solution enhances Microsoft Dynamics NAV, making it a robust ERP system for contract manufacturing. It optimizes resource utilization, ensures accurate tracking of production orders, and supports efficient operations for businesses engaged in contract manufacturing. We offer the best ERP software for Manufacturing.