What is Inventory?

Inventory comprises items a company holds for:

• Raw Materials: Basic inputs waiting to be processed.
• Work in Progress (WIP): Partially completed goods still undergoing production.
• Finished Goods: Completed products ready for sale.

Why is Inventory Important?

Inventory is crucial because it:

• Facilitates Sales: Ensures products are available to meet customer demand.
• Impacts Cash Flow: Ties up capital; excessive inventory can strain liquidity, while shortages can lead to lost sales.
• Influences Profitability: Inventory valuation methods affect cost of goods sold and gross margin.

How is Inventory Calculated?

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

Inventory = Sum(Quantity on Hand × Unit Cost)

Common cost-flow assumptions include:

• FIFO (First-In, First-Out): Assumes earliest acquired items are sold first.
• LIFO (Last-In, First-Out): Assumes most recently acquired items are sold first.
• Weighted Average: Averages costs over the period.

Additional Considerations

• Turnover Ratios: Inventory Turnover (COGS ÷ Average Inventory) measures how quickly stock cycles.
• Days Inventory Outstanding (DIO): Average days inventory is held before sale, indicating efficiency.
• Obsolescence Risk: Excess or slow-moving inventory may require write-downs to net realizable value.