Definition of Inventory
A large part of the total assets of a retail or wholesale business is inventory. Goods which are purchased for the purpose of sale and are available in salable condition on a particular date are called inventories.
Inventory will be converted into cash by sale in less than one year. For this, inventory is considered as current asset. In the Statement of Financial Position/Balance Sheet, inventories are shown in the Current Assets column. Inventories are just one step away from being converted into cash.
Generally, not all goods purchased by an organization are sold during a specific accounting period. The cost of all these purchased products can be divided into two parts.
a) Cost of goods sold and b) Cost of unsold goods
Note: Service-based business hasn’t any inventory, as there is no activity of buying and selling of goods.
Objective and Importance of Inventory Evaluation
The price of inventory has a considerable influence on determining the financial results and status of the business. Moreover, it is one of the important parts of working capital.
1) Current Assets Status: Assessing reserves is essential for determining current assets.
2) Supply of Goods: Knowing the adequacy of supply of goods in the context of consumer demand in the future.
3) Cash Inflow Forecasting: Estimating the amount of cash that will flow into the business by selling inventories.
4) Determining Working Capital: Find out the solvency of the organization, to determine the ratio of current assets and current liabilities i.e. working capital ratio.
5) Control over the Gross Profit: Inventory valuation is done to determine the cost of goods sold to know the gross profit.
6) Extent of Losses: Losses caused by fire or other accidents need to be measured and settled for insurance claims.
7) Display in Financial Statements: Determining the financial position of the business by displaying the net worth of the stock in the Statement of Financial Position/Balance Sheet on the last day of the accounting period or in the interim period.
More Resources
Thank you for reading our resources on the Inventory. Enhancing your knowledge more and progressing in your career, you may find the following guides helpful: