Understanding NetSuite Standard Costing and Average Costing Methods: Pros, Cons, and Ideal Scenarios

Introduction: 

NetSuite, a popular cloud-based Enterprise Resource Planning (ERP) system, offers two primary inventory costing methods: Standard Costing and Average Costing. Each method has its strengths and limitations, making them suitable for specific business scenarios. In this article, we will explore the pros and cons of both methods and provide insights into which one best suits various situations.

NetSuite Standard Costing Method:

 Standard costing is a widely used inventory costing approach that establishes predetermined costs for materials, labor, and overhead. These predetermined costs remain fixed throughout a specific period, regardless of the actual purchase or production costs. The Standard Costing method works well for businesses with stable production processes and minimal fluctuations in material prices.

Pros:

• Predictability: Standard costing provides a stable and predictable cost structure, making it easier for businesses to plan and budget accurately.
• Simplified Accounting: With fixed costs, accounting processes become more straightforward and do not require frequent adjustments.
• Performance Measurement: Standard costing facilitates performance evaluation by comparing actual costs against predetermined standards, helping identify variances and inefficiencies.

Cons:

• Lack of Real-Time Accuracy: Since standard costs remain static, they may not reflect current market conditions, leading to discrepancies between actual and recorded costs.
• Labor-Intensive Updates: When material or production costs change significantly, updating standard costs across all relevant items can be time-consuming.
• Less Adaptive to Market Fluctuations: Standard costing may not be suitable for businesses dealing with volatile markets or industries with frequently changing prices.

Ideal Scenarios for NetSuite Standard Costing:

• Manufacturers with stable production processes and predictable material costs.
• Businesses dealing with highly standardized products and consistent production volumes.
• Companies with a focus on cost control and long-term planning. 

NetSuite Average Costing Method:

 Average costing calculates the cost of inventory by averaging the purchase or production costs of similar items over a specific period. As a result, the recorded cost per item can fluctuate with each new purchase, providing a more real-time and market-responsive inventory valuation.

Pros:

• Real-Time Cost Reflection: Average costing reflects current market conditions, making it suitable for businesses dealing with volatile material prices or industries with changing market demands.
• Less Administrative Effort: Since average costs are automatically calculated based on purchase transactions, updating inventory costs requires minimal manual intervention.
• Fair Cost Allocation: Average costing can distribute cost fluctuations across all units in stock, preventing overvaluing or undervaluing inventory during price changes.

Cons:

• Complexity in Accounting: Due to the constant fluctuations in inventory costs, accounting for average costing can be more intricate than standard costing.
• Challenging Performance Measurement: Comparing actual costs with dynamically changing average costs can make it harder to evaluate performance accurately.
• Potential Misrepresentation: In periods of significant cost variations, average costing may not accurately represent the true cost of individual items.

Ideal Scenarios for NetSuite Average Costing:

• Retailers and distributors dealing with frequent price changes and market fluctuations.
• Businesses that need real-time inventory valuations for accurate financial reporting.
• Companies with diverse product lines and irregular production costs.

How We Can Help You

Folio3 is a reputable company known for its expertise in ERP implementations, and they can provide valuable assistance to clients facing the above scenarios. Here’s how Folio3 can help clients with the implementation of ERP while handling the different costing method scenarios:

• Customization and Configuration: 

Folio3’s experienced team can tailor the ERP system to match the specific requirements of the client’s business and their preferred costing method. For standard costing, they can configure the system to accommodate predetermined costs for materials and overheads. For average costing, they can set up the system to calculate and update costs based on real-time purchase transactions. This ensures that the ERP system aligns perfectly with the client’s chosen costing approach.

• Training and Support: 

Folio3 provides comprehensive training to the client’s team to ensure they can effectively use the ERP system for daily operations, regardless of the chosen costing method. They can offer detailed guidance on how to set up standard costs, handle average costing calculations, and interpret the system-generated reports. Additionally, Folio3 offers ongoing support to address any questions or issues that may arise during and after the ERP implementation.

• Cost Management Analysis: 

For clients opting for standard costing, Folio3 can help establish cost control measures by analyzing actual costs against predetermined standards. By identifying variances and inefficiencies, they can assist clients in making informed decisions to improve cost management and operational efficiency.

• Market Sensitivity Solutions:

Clients adopting average costing may face market fluctuations and changing prices. Folio3 can implement systems that help monitor material price trends and provide insights into inventory valuation in real-time. This ensures that the client maintains accurate cost calculations, preventing overvaluing or undervaluing inventory during price changes.

• Performance Measurement Tools: 

For both costing methods, Folio3 can set up performance measurement tools within the ERP system. This allows clients to track key performance indicators (KPIs) related to inventory costs, production efficiencies, and financial performance. These KPIs assist in evaluating the effectiveness of the chosen costing method and identifying areas for improvement.

• Scalability and Flexibility: 

Folio3 ensures that the ERP implementation is scalable and flexible enough to accommodate future business growth and changes in costing preferences. Whether the client’s needs evolve over time or they decide to switch from one costing method to another, Folio3 can support these transitions seamlessly.

Conclusion: 

Both NetSuite Standard Costing and Average Costing methods have their advantages and disadvantages, making them suitable for different business scenarios. Standard costing is more suitable for stable and predictable environments, allowing for easier budgeting and planning. On the other hand, average costing provides real-time cost reflection, making it ideal for industries with volatile markets or fluctuating material prices.

Ultimately, the choice between these methods depends on your business’s specific needs and requirements. Businesses should carefully consider their production processes, inventory dynamics, and market conditions to determine which costing method aligns best with their goals and objectives. Furthermore, it’s essential to monitor the effectiveness of the chosen costing method regularly and be prepared to adapt to changing circumstances if necessary.

Folio3, with its expertise in ERP implementations, can help clients successfully navigate the challenges posed by different costing methods. By providing customized solutions, training, and ongoing support, they ensure that the ERP system aligns with the client’s business processes and optimally handles standard costing or average costing scenarios. With Folio3’s assistance, clients can maximize the benefits of their ERP investment and streamline their operations for improved efficiency and profitability.