Understanding the cost of your inventory isn’t just about keeping numbers straight; it’s about gaining insights that drive profitability, improve operational efficiency, and enhance decision-making. But what is inventory costing, and why does it matter so much to your financial strategy?
Most manufacturing companies use a standard costing system under a first-in
and first-out (FIFO) method. Under a standard costing system, predetermined costs for material, labor and overhead are established and used to determine the cost of the inventory. Management can then compare the actual cost to the standard cost to monitor and manage production performance through production and price variances.
Why Accurate Inventory Costing Matters
Whether you’re exploring the cost of inventory management systems to streamline operations or simply wanting a clearer financial picture, understanding accurate inventory costing is key for several reasons:
1. Accurate Financial Reporting
This one is simple and it will make your auditors happy. Accurate standard cost inputs help in determining the overall value of inventory which is essential for fair and accurate financial statements. This ensures that the balance sheet and income statement reflect a true financial picture of the business. Significant increases in production or pricing variances (actual costs versus standard costs) may be an indication that it is time to revisit and adjust your standard costs.
2. Pricing Decisions
Knowing the true cost of inventory helps businesses set appropriate prices for their products. Management can then calculate pricing strategies that cover the manufacturing cost and a desired profit margin. Many businesses will take this one step further to understand the full cost of the customer relationship by assessing non-inventory costs which may include customer returns, rebates and other allowances, technical support or any extras needed to maintain the customer relationship.
3. Production and Other Decision-Making
Finally recording proper quantities and costs allows your materials requirement planning (MRP) process to work properly. This includes such processes or decisions such as when to reorder raw material stock and how much to order so the necessary materials are on hand to meet the production schedule.
The Role of an Inventory Management System
Implementing an inventory management system can greatly enhance the accuracy and ease of inventory costing. But what is the true cost of an inventory management system, and how does it influence the overall cost of inventory?
A robust inventory management system tracks materials and finished goods in real time, helping you reduce errors and identify cost-saving opportunities. Although the initial cost of an inventory management system may seem high, the potential savings through optimized stock levels, minimized manual errors, and improved supply chain coordination can lead to significant long-term cost reductions. Additionally, as your business grows, these systems scale with you, providing flexibility that manual methods can’t offer.
Key Takeaways on Inventory Costing
Inventory is the “lifeblood” of any manufacturing business. A firm understanding of your inventory costs gives you more than just numbers—it provides insights that drive smarter purchasing, production, and pricing decisions. In the long term, tracking these costs carefully contributes to a healthier bottom line and stronger financial foundation.
At Meaden & Moore, we know manufacturing. And we differentiate ourselves by investing the time to deeply understand your business. We customize our services to fit your unique needs and deliver solutions that align with your objectives.
Reach out to us today to explore how we can help you navigate challenges and achieve lasting success.
