Are “Standard Costs” Going the Way
of the Dinosaur?
Introduction
Accurate financial forecasting is essential for businesses to maintain stability, optimize resources, and make informed strategic decisions. A key consideration in forecasting is whether to use Actual Costs or Standard Costs. While standard costs have traditionally been used for budgeting, leveraging actual costs for monthly forecasting offers a more precise and dynamic approach.
Understanding “Actual” vs. “Standard” Costs
Standard Costs are predetermined estimates assigned to materials, labor, and overhead based on historical data, industry benchmarks, or internal assumptions. They serve as a baseline for budgeting and cost control but may not reflect real-time fluctuations.
Actual Costs, in contrast, capture real expenses incurred for materials, labor, and overhead. These costs reflect ongoing market conditions, operational efficiencies, and other variables, offering a more accurate picture of financial performance.
Why Actual Costs Improve Monthly Forecasting
1. Enhance Forecast Accuracy – Monthly forecasts based on actual costs ensure that predictions align with real financial data, improving precision. Standard costs, being fixed estimates, can lead to deviations that reduce forecast reliability.
2. Improved Responsiveness to Cost Fluctuations – Standard costs do not account for unexpected changes in material prices, labor rates, or operational expenses. Actual costs, however, capture these fluctuations, allowing businesses to update forecasts accordingly and mitigate financial risks.
3. Better Cash Flow Management – Using actual costs enables more effective cash flow planning by providing real-time insights into expenditure patterns. This helps businesses allocate resources more efficiently and avoid cash shortfalls.
4. More Accurate Profitability Projections – Monthly forecasting with actual costs ensures that profit margins reflect real cost structures. Standard costs may create artificial profitability assumptions that misguide decision-making.
5. More Effective Cost Control – Tracking actual costs helps identify inefficiencies and cost overruns early, allowing corrective actions to be taken before they significantly impact financial performance. Standard costs provide only a reference point, requiring variance analysis that may delay corrective measures.
Alignment with Data-Driven Financial Strategies – Modern financial planning increasingly relies on real-time data analytics. Actual costs integrate seamlessly with advanced forecasting tools, AI-driven models, and predictive analytics, improving the accuracy and relevance of financial projections.
Strategic iQ, with OneStream, Can Bring Actual Costs to Your Fingertips for Forecasting
By integrating actual costs into your forecasting process (and streamlining that process), you can ensure that your monthly performance reviews have a clear understanding of your current operational execution and can project ahead with more accurate profitability expectations.
Strategic iQ has empowered our customers with:
- Monthly Part Level Profitability: SiQ can organize your data so that you can see Part-Level or SKU-Level profitability (down to Bill of Materials) on a monthly basis.
- Direct & Indirect Actuals: SiQ can support leveraging complex allocation logic to extend your profitability analysis to include indirect costs down to Part of Production Line.
- Driver-Based Forecasting: SiQ, even while leveraging significantly more operational data than most planning solutions, can streamline and simplify your monthly forecasting process allowing you to take advantage of driver-based forecasting. Our clients typically make only a handful of changes to their forecasts, allowing their most current demand model to generate the bulk of their forecast.
- Integrated Data Sources: It connects directly to ERP systems to pull actual costs, ensuring that forecasts are based on up-to-date financial data without manual uploads.
- Improved Executive Visibility: Built-in dashboards allow your executives to see a combination of metrics, including financial performance metrics, but also key operational ones (Downtime, Labor Variance, Overtime, Scrap, etc.) and Working Capital ones (DIO, DSO, DPO, Cash Conversion, etc.).
Conclusion
For businesses aiming to enhance their financial forecasting process, consider leveraging a solution that empowers you to leverage and analyze actual costs. While the current standard cost approach offers a foundational reference, it lacks the flexibility and real-time accuracy required for effective monthly forecasting. By integrating actual costs into your forecasting models, you can improve your financial planning, optimize resource allocation, and drive better business outcomes.
