Inventory valuation is one of the ways in which you can find out the cash amount associated with the goods in stock at the end of the accounting period. The process of stock valuation depends on the costs incurred to obtain and prepare the stock for sale Inventories are the largest current business assets, and stock valuation allows you to evaluate the cost of goods sold, and ultimately determine your profitability, and in this article we will show you what is meant by stock valuation, its importance, and the most important ways to calculate it.
What is inventory valuation?
Inventory valuation is an accounting practice that companies follow to find out the value of their unsold inventory at the time they prepare their financial statements.
Inventory is an asset to the organization, and to be recorded on the balance sheet it must have a financial value.
This value can help you determine your inventory turnover ratio, which in turn will help you plan your purchasing decisions.
get to know : Weighted Average Cost wac method
What are the different inventory valuation methods?
The method for valuing inventory depends on how the business tracks inventory over time, and the business must value inventory at cost.
There are 5 ways to evaluate the company’s inventory, and the following are those methods:
Weighted Average Cost (WAC)
Using the WAC valuation method, inventory and cost of goods sold are based on the average cost of all items purchased during a period.
This method is typically used when a business does not have a significant variance in its inventory.
And the average cost per unit is calculated by dividing the total cost by the total number of units purchased during the year.
- Weighted average cost per unit = Total cost of goods in inventory / Total units in inventory
This method is also commonly used to determine the cost of units which are indistinguishable from each other and it is difficult to track individual costs.
First in, first out (FIFO)
This method is based on the premise that the first inventory that is purchased is the first that is sold, and the remaining assets in inventory are matched to the assets that were recently purchased or produced.
It is one of the most common inventory valuation methods companies use because it is simple and easy to understand.
During inflation, the FIFO method results in a higher value for final inventory, a lower cost of goods sold, and a higher gross profit.
Unfortunately, the FIFO model fails to provide an accurate depiction of costs when there is a rapid rise in prices, and this method does not offer any tax advantages.
And it is one of the common inventory valuation methods.
Last in, first out (LIFO)
Under this inventory valuation method, the newest inventory is assumed to be sold first while the oldest inventory remains in stock.
Companies rarely use this method because old inventories are rarely sold and gradually lose value, and this results in significant loss to the business.
The only reason to use LIFO is when companies expect the cost of inventory to increase over time and lead to price inflation.
By moving high-cost inventories to the cost of goods sold, companies’ reported profit levels can be lowered, and this allows companies to pay lower taxes.
First Expired, First Out (FEFO)
The FEFO method is a method in which the goods with the closest expiration period must be removed or sold first, regardless of whether the goods entered the warehouse first or later.
The FEFO method is commonly applied by food retailers and pharmacies, and products containing semi-expired products are usually placed in front shelves or in easily accessible places.
This is so that customers can take it right away, and products with a long shelf life are usually stored in the warehouse first.
Under this method, every item in your inventory is tracked from the time it is stored until it is sold, and is typically used for large, easily identifiable items.
This method has different advantages and costs, and the prerequisite for this method is that you must be able to track each item individually.
This can be done through the use of an RFID tag, a stamped receipt date, or a serial number.
While this method offers a high degree of accuracy in stock valuation, it is limited to valuing rare, high-value items that require such discrimination.
Is Inventory an Asset?
Yes, inventory is one of the most important assets of the company; in fact, it is one of the largest current assets of companies.
So a monetary value is provided to the components that make up the inventory in what is known as inventory valuation.
Where the inventory must be evaluated correctly in order to ensure the accuracy of the financial statements.
If the inventory is not measured correctly, this will lead to the mismatch of expenses and revenues in the correct way.
This leads to incorrect business decisions, and for inventory accounting, the periodic inventory system and the perpetual inventory system are used.
We find that in the periodic inventory system, sales are recorded when they occur without updating the inventory, while in the perpetual inventory system, accounting records are always provided that show the amount of stock available.
Also, records are kept for each item in stock in the ledger, and the account is updated every time a sale or purchase is made.
Since the perpetual inventory system requires determining the cost of goods sold, multiple inventory valuation methods must be used.
get to know : 5 Types and tips to reduce the Inventory Costs
Importance of inventory valuation
The inventory valuation process plays an important role in determining the company’s financial position.
The following are the most important benefits of inventory valuation:
- Determine the company’s financial position. A wrong inventory calculation can affect the correctness of the company’s financial statements such as net income and profit or loss in the current year.
- Calculate liquidity ratios that help in knowing how easy it is to convert inventory into cash.
- Take advantage of tax deductions, so inventory costs can be deducted from gross income while reporting to the IRS.
- Determining the financial value of the stock in case the company is sold or acquired.
- Follow-up of the overhead costs on inventory, especially the costs of purchasing merchandise.
Inventory Management and Valuing Your Inventory with Diggipacks
Diggipacks gives you the best technology that will help you in managing inventory and valuing your inventory.
This is done by following the latest technological methods that enhance the efficiency of your business and make it more flexible and in line with the challenges of the markets at the present time.
Diggipacks has extensive experience in logistics and provides smart solutions for businesses and online stores. Thus, it can help you with your company’s Inventory valuation.
And that through a team of specialists in the field of logistics. So whatever the size of your business, Diggipacks puts your business first, helping you keep it going.
This will give you a real opportunity to keep track of your inventory, shipping, delivery options rates, and financial reports.