What is Inventory?

Inventory consists of all products and materials a company holds at various stages of production or ready for sale. It typically includes:

• Raw Materials: Basic components used in manufacturing.
• Work in Progress (WIP): Partially completed goods in the production process.
• Finished Goods: Completed products ready for sale.

Why is Inventory Important?

Inventory is important because it:

• Supports Sales: Ensures adequate stock to meet customer demand without delays.
• Impacts Cash Flow: Ties up capital; excessive inventory can strain liquidity, while insufficient inventory can lead to stockouts.
• Affects Profitability: Inventory valuation methods influence cost of goods sold (COGS) and gross profit.

How is Inventory Calculated?

Inventory is valued and reported on the balance sheet at the lower of cost or net realizable value using methods such as:

Inventory = Sum of (Quantity on Hand × Cost per Unit)

Common valuation methods include:

• FIFO (First-In, First-Out): Assumes oldest items sold first.
• LIFO (Last-In, First-Out): Assumes newest items sold first.
• Weighted Average Cost: Averages cost of all items.

Additional Considerations

• Inventory Turnover: Ratio of COGS to average inventory measures how quickly stock is sold and replaced.
• Days Inventory Outstanding (DIO): Average days inventory is held before sale, indicating efficiency.
• Obsolescence Risk: Unsold inventory may become obsolete or require write-downs, impacting profitability.