Dynamics 365 Business Central Costing Methods and Application
Dynamics Business Central provides several costing methods tailored to meet various business needs. Understanding these methods and knowing when to apply them can significantly impact your financial decision-making and overall business success.
Costing methods in D365 Business Central define how items are valued when they leave inventory and are designed to accurately allocate costs to products or services. The costing methods supported in Business Central are:
- Standard Costing: Standard costing is best for businesses with stable production processes and predictable costs. It establishes predetermined costs for materials, labor, and overhead and provides a benchmark for evaluating estimated vs. actual costs. Businesses operating in industries with consistent production cycles, such as manufacturing or assembly, benefit from standard costing.
- FIFO (First-In, First-Out): FIFO assumes that the oldest inventory items are sold first. This costing method is best for businesses that sell perishable goods or where product obsolescence is a concern. FIFO is often used in industries like food, pharmaceuticals, or electronics, where rapid inventory turnover and maintaining product freshness or relevance is crucial.
- LIFO (Last-In, First-Out): Conversely, LIFO assumes that the newest inventory items are sold first. This method works best for businesses facing inflationary pressures because it assigns higher costs to the goods sold, lowering the company’s tax liability. However, LIFO can complicate inventory management and might not accurately reflect the actual cost of physical inventory. Industries that are sensitive to rising costs, such as retail or automotive, might use LIFO costing methods. It should be noted that LIFO is not allowed in some countries due to its impact on profit calculations.
- Average Costing: Average costing calculates the average cost of inventory items based on their total cost and quantity. Average costing is well-suited for industries with continuous production processes, such as chemicals or textiles.
- Specific Costing: Specific costing lets businesses allocate costs directly to individual items. This method provides accurate costs but requires detailed record-keeping. This type of costing is often used for high-value or customized products, such as jewelry or artwork. This costing method requires additional steps for users to ensure costs are properly assigned. This can be daunting in some high-paced environments and should be thoroughly tested and approved before being selected.
Various factors, including financial reporting, tax obligations, and decision-making processes, influence the choice of the appropriate costing method.
A general note on costing by Lot and/or Serial Number: If a company uses Lot and/or Serial Number tracking for inventory, procedures and reporting should be available to report on specific costs, sometimes called landed cost, for that inventory regardless of the costing method chosen for accounting purposes.
So, when should businesses leverage these costing methods?
- During Initial Setup: Selecting the most suitable costing method during the implementation phase of Dynamics 365 Business Central sets the foundation for accurate financial management. Assessing factors like inventory turnover, cost volatility, and industry standards helps executive leadership make informed decisions.
- Periodic Review and Adjustment: Business dynamics change over time, prompting the need to review and adjust costing methods periodically. Changes in market conditions, production processes, or regulatory frameworks may necessitate a shift to a more relevant or efficient costing approach.
- Strategic Decision-Making: Costing methods are important for strategic decision-making, such as pricing strategies, inventory management, or investment evaluations. Businesses must align their costing practices with broader strategic objectives to optimize profitability and competitiveness.
By understanding the differences between each costing method and the optimal time to apply them, businesses can operate more efficiently, mitigate risks, and drive sustainable growth in today’s dynamic business environment. Contact ArcherPoint for help with setting up or changing your costing method in Business Central.