Through December 2022, the Consumer Price Index had increased on average approximately 6.5% annually for the twelve months then ended. The supply costs for manufacturers during this time were no different, with many companies scrambling to find ways to keep up with the aggressive price increases they were experiencing from vendors across most, if not all, industries. As a result, the cost to produce inventory has increased dramatically and is projected by most economists to continue through 2023.
Many manufacturers utilize a standard costing approach to valuing their inventory. Standard costing is generally based on the expected costs of material, labor, and overhead needed to produce inventory and is established by most companies at the start of the year. As we look into 2023 and beyond, it becomes increasingly more important for manufacturers to accurately capture these costs when determining their standard costs. Now, more than ever, it is important for management to assess the accuracy of its standard costs against actual and the need may arise to revisit certain standard costs sooner than usual if experiencing significant changes in actual versus expected costs.
Management generally will make decisions using standard costing data when evaluating cost of goods sold, gross margin and gross margin percent. This could include determining which individual products and product lines are most profitable, which geographies the company is performing best, and which areas may not be performing as expected. Having accurate standard costing is pivotal to be able to assess this data and to appropriately make informed operational decisions on where to direct selling efforts to products and areas providing the most value.
Having accurate standard costs is also crucial in setting prices at which to sell products. It is an unprecedented time in the ability for companies to pass down costs by increasing prices. As the economy’s performance begins to wane, it will become more and more difficult to pass on these cost increases. Therefore, time is of the essence in understanding the actual costs of inventory, to be able to act quickly.
An unpredictable, highly inflationary economy makes it difficult for even the most sophisticated budgeting process to get it right when setting standard costs. As such, companies should assess whether it is time to evaluate their standard costs on a more frequent basis than annually to make informed and accurate business decisions. It would be recommended for management to keep a close eye on purchase price variances, and labor/overhead variance on a month-to-month basis. If experiencing significant swings in these accounts, it may be indicative that a change to the standard is necessary.
As inflationary pressures begin to come down and the cost of supplies approach normal levels, companies can relax the level of scrutiny placed on this process. However, constant vigilance during these uncertain times is not only warranted but essential to ensuring management makes knowledgeable decisions in managing prices, product strategy and inventory maintenance.
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