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The Datacor Blog

Guide to Costing Methods for Manufacturing

November 29, 2022 by Jinelle Park

Keeping track of costs ensures healthy margins. An automated system saves time and ensures accurate inventory valuation. Datacor ERP can help to calculate costs both today and ahead.

Understanding and applying the appropriate costing methods to your business has likely never been so important given the current economic volatility. The bottom line is that companies stay in business if they have good profitability – and that means knowing what your costs are.

In simple terms, a costing method assigns the cost of producing a particular product within an ERP system. It is used to monitor inventory, profitability and costs.

If you have accurate costing, then you know exactly how much inventory you are sitting on. If the inventory value goes up, then it could be a red flag to indicate overstocking. To the same end, accurate costs will give a precise view of margins.

A Choice of Alternatives

There are a few costing methods to choose from. The three most common are weighted average, standard, and lot or actual cost.

The weighted-average method is very popular among manufacturers. Essentially, every time a business purchases product, the system looks at how much is currently sitting in inventory, what the cost of that is, what the company is buying next and at what volume – pounds, tons, gallons, liters – and takes a weighted average. Companies like this method because it smooths out price spikes.

An alternative is standard cost. Under this method, companies assign a cost for a raw material, setting an expectation of costs over a period of time and measuring against that. Take glycerin – used in haircare products – as an example. I believe I can get glycerin for $3/lb, so every time I buy, I assign that cost to my inventory. But, if the glycerin costs say $3.25 the next time I buy, I book the difference – 25 cents – to a standard variance account.

When I finally sell my formulated product, my profit has to be measured against the variance account, so it could be higher or lower versus my standard cost account, depending on my variances.

A third – and more granular method – is lot or actual cost. As the name implies, the method assigns the cost to inventory of each incoming lot or batch, linking back to the specific purchase order. This has the benefit of giving manufacturers the precise cost of the product, but it also highlights all price spikes.

Regardless of which method your business uses, Datacor ERP software automatically tracks all costs – from purchase orders to receipt of incoming material, constantly recalculating and updating the value of inventory, cost of production and the sale price of finished goods.

Unique Conversion Capability

What makes Datacor’s system unique is that it can automatically convert different measurements of volume and differing currency units, removing potential for error and removing complexity.

So, when I have to split the cost of a container that held several separate deliveries of raw materials in different units, for example, kilos, pounds or liters, the system can apportion the cost of all those ingredients in one unit of measure. Tracking and converting units on spreadsheets can get pretty hairy, pretty quickly and systems that have not been designed to handle this level of complexity rarely do it well – or accurately!

Looking Ahead

Another useful component of the Datacor software is the ability to calculate what it terms replacement cost, in other words the price of a particular raw material in the future.

For instance, I receive notice that one of my suppliers is increasing its prices from a specified date, say January 1. The system stores that data as a new purchase cost after that date, enabling me to see what the future cost of production will be and how much I need to raise the price of my final product after January 1 to maintain margin. Companies can model this ability on a variety of factors, including suppliers’ notices of a price increase, supply chain problems, and unexpected plant outages, for example.

Making informed pricing decisions on the basis of accurate costing methods – plus keeping an eye on the value of your inventory – are crucial to maintaining a healthy business. If you haven’t implemented an effective costing method, then now is as good a time as any, especially given the current economic and geopolitical uncertainty that is dominating the global outlook.

Frequently Asked Questions (FAQs)

What is a costing method in manufacturing?
A costing method is an application within an ERP system for monitoring costs, inventory and profitability, helping to maximize margins and minimize losses.

How can costing software help my business?
It can provide a precise view of your production costs over a specified timeframe, recording raw material costs, purchase orders, inventory value, and sales orders and providing a view on profit margin.

How do I choose the best costing method?
There are several to choose from, so make sure you identify what the business needs and adopt one that complements your existing processes.

To learn how Datacor can help your company streamline operations and increase efficiency, sign up for a personalized demo today.

Topics: ERP, Datacor ERP

Jinelle Park

Written by Jinelle Park

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