- Your costing method decides which cost is used when you sell from inventory bought at different prices.
- FIFO follows oldest cost first, Average smooths price swings, Standard uses a fixed cost and surfaces variances.
- You cannot change an item's costing method once it has inventory ledger entries; changing it later means a manual workaround.
- Decide the method per item before you start transacting, because setup decisions are cheap and later changes are not.
A couple weeks back, the finance lead at an inventory-carrying business asked a deceptively simple question. Picture a bin holding three of one item: you bought the first in January for $10, the second in March for $12, and the third last week for $14. A customer orders one. Which cost does your system relieve from inventory when it ships?
That setting is your costing method, and if you carry inventory, your enterprise resource planning (ERP) system, the software that runs finance and operations together, answers it on every transaction. In Dynamics 365 Business Central, Microsoft's ERP for small and mid-sized businesses, you'll want to get it right early, because it comes with a trap attached.
The methods, in plain terms
Business Central offers five costing methods, but most businesses live on one of three.
- FIFO (first in, first out). Uses the oldest cost first. When prices are rising, FIFO shows a lower cost of goods sold and higher reported profit, and it mirrors how most goods move off a shelf.
- Average. Blends purchase costs into a weighted average, so no single buy swings your margins when prices move.
- Standard. You set a predetermined cost for each item, which gives manufacturers a stable cost to plan and price against.
The other two are LIFO (last in, first out), which uses the newest cost first, and Specific, which tracks the actual cost of each unit and suits serialized or unique items. Both are far less common for a small or mid-sized business.
| Method | What it uses when you sell | Tends to suit |
|---|---|---|
| FIFO | the oldest cost still in stock | businesses whose goods physically move oldest-first |
| Average | a weighted blend of all costs | distributors with bouncy purchase prices |
| Standard | a fixed, predetermined cost | manufacturers who plan and price against a standard |
What makes standard costing different
With FIFO or average, the cost is derived from what you paid. With standard, you tell the system in advance what an item costs, and reality never matches exactly.
Business Central handles the difference through variances: when the actual cost comes in higher or lower than the standard, it posts the difference to separate variance accounts. That's the real value of the method, surfacing the gap between expected and actual cost where finance sees it.
The tradeoff is discipline: someone has to keep the standards current and review the variances rather than letting them pile up.
The gotcha: set the method before you post
In Business Central, you can't change an item's costing method once that item has inventory transactions, what the system calls item ledger entries, posted against it. Once you've received or sold against it the method is locked, since changing it would invalidate the cost history.
The costing method is cheap to set during setup and expensive to undo after a year of postings. Decide once, per item, before anything posts.
If you genuinely need to change the method for an item already in use, the path is deliberate: create a replacement item with the correct method and transfer the existing inventory to it. It's the kind of thing you want an experienced partner to handle.
How to choose
The table above is the short version, with the caveat that standard costing pays off only if you maintain the standards.
The right answer depends on your business, your industry, and how your accountant wants to read your statements. Make it once, with your finance team and implementation partner in the room, because it's far easier to set than redo.
Let's talk it through
If you're setting up items, or you're not sure the method you're on is right, we're happy to think it through before anything locks in. Our team comes from accounting and operations, so we frame it around how you run inventory. Reach out.