Average Cost is a cost calculation method in NetSuite that provides the weighted average of all costs incurred to purchase and maintain an item in stock. This value smooths out the fluctuations in purchase prices by providing a single, average figure that is updated each time inventory is received or adjusted.
Key aspects of Average Cost:
- Calculation Method: The Average Cost is calculated by dividing the total dollar value of inventory on hand by the total quantity of that item. For example, if you purchase 100 units of an item at $10 and later buy another 50 units at $12, the average cost will be based on the combined value of both purchases.
- Location-Specific Costing: Each inventory location can have its own average cost for an item. This means that even if the same item is purchased at different prices across different locations, NetSuite calculates and tracks an average cost specific to each site.
- Transaction Impact: Every transaction that affects the inventory, such as Item Receipts, Inventory Adjustments, and Transfer Orders, will adjust the average cost. As new stock is added to inventory at different purchase prices, the average cost is recalculated to reflect the total cost of inventory on hand.
- Multi-Location Inventory: For companies using Multi-Location Inventory, NetSuite offers the Group Average Costing option, which calculates an average cost across all locations in a group. This creates consistency by ensuring that all locations under the same group use the same average cost value.
- Stabilizes Cost Fluctuations: The Average Cost method is useful in industries where prices fluctuate frequently. It helps to stabilize cost valuation, providing a more consistent view of inventory cost over time. It prevents significant swings in cost calculations that could affect profitability analysis.
Importance of Average Cost: Average Cost is essential for accurate inventory valuation. It smooths out price volatility, ensuring that reports and financial statements provide a consistent reflection of stock value. This method is especially useful for companies that have frequent price changes or buy large quantities of inventory over time, allowing for more accurate profit margin calculations.