Inventory on the Balance Sheet

 What is a Balance Sheet?

The assets and liabilities of a company are described in a balance sheet at a single point in time. A balance sheet accurately shows a company’s financial situation because it shows its current worth.

Your company’s accounting department, owners, executives, and other stakeholders will use a balance sheet to assess the company’s finances.

What can I find on a balance sheet?

A balance sheet lists all the assets and liabilities of your business as of a specific date, such as the end of the fiscal year.

Inventory is a current asset on a balance sheet that can be converted into cash within a year. But how do you calculate the inventory value for a balance sheet?

If everything is put together correctly, your most liquid assets should be at the top of your balance sheet. Listing assets in descending order of liquidity will help your team see the amount of “cash” more clearly.

Is inventory an asset?

Yes, inventory is considered an asset on a company’s balance sheet. This is because inventory represents goods that a company has purchased or manufactured to sell to customers at a later date, and these goods have a value that can be realized in the future.

There are several reasons why inventory is considered an asset:

1. Inventory has value: The goods that make up a company’s inventory have a monetary value, which can be realized when the goods are sold.

2. The company owns inventory: The goods that make up a company’s inventory are owned by the company and can be used to generate revenue or profits.

3. Inventory can be converted into cash: Inventory can be sold to customers for cash, which can be used to pay expenses or invest in the business.

4. Inventory is necessary for business operations: Depending on the type of business, inventory may be necessary for day-to-day operations or to meet customer demand.

Overall, inventory is considered an asset because it represents the value that can be realized in the future and is owned by the company.

1. Assets- Balance Sheet

Current assets- Balance Sheet

Anything your company owns and is likely to be converted into cash within a year is considered a current asset. Examples include:

1. Money in your business checking or savings accounts is an example of a cash, check, or cash equivalent.

2. Raw materials, work in progress, and finished goods are all included in the inventory.

3. Investments that can be quickly sold in the next year

4. Expenses that have been paid in advance, such as rent for your office, insurance, or your internet bill, which are paid yearly

5. Unpaid invoices—if your terms of payment for invoices permit customers to pay later for goods or services, the cash you will soon receive is still regarded as a current asset.

Long-term assets- Balance Sheet

Unlike current assets, long-term assets cannot be turned into cash within a year. Long-term assets include, for instance:

1. Real estate, physical structures, computers, machinery, and equipment are fixed assets.

2. Investments that are difficult to sell within a year

3. Intellectual property rights and other intangible assets

3. Liabilities- Balance Sheet

A liability is a balance that your company owes. Your balance sheet will also include liabilities, which can be divided into current and long-term liabilities.

Current liabilities- Balance Sheet

Liabilities that are due right away are referred to as current liabilities. This includes recurring costs like rent, utilities, payroll, interest, and business taxes.

Long-term obligations- Balance Sheet

Long-term liabilities are debts your business owes and will take a long time to pay off. Deferred business income taxes and long-term loans both constitute long-term liabilities. Additionally, if your company has chosen to participate in a pension fund, those liabilities are also long-term.

4. Ownership equity

Finally, a balance sheet will also include information about shareholders’ equity. A company’s net worth, or shareholders’ equity, is determined by deducting all liabilities’ value from all assets’ value.

Calculating the value of inventory for a balance sheet

Raw materials work in progress, finished goods, and overhauls are the four categories of inventory. And your balance sheet includes all of this inventory.

Identifying which inventory is a current asset is the first step. Remember that some of the machinery and equipment on your inventory list, such as laptops or ultrasound machines, may be long-term assets. Since they won’t be turned into cash within a year, these long-term assets aren’t accounted for as inventory on a balance sheet.

What is Inventory?

The total amount of raw materials, work-in-progress, and finished commodities a company has amassed is represented by its inventory. This current asset account may be found on the balance sheet. It is frequently regarded as the least liquid of all current assets. Hence it is left out of the numerator when calculating the quick ratio.

The interaction between the cost of goods sold in the income statement and the inventory account is examined in greater detail below.

Inventory Explained

Depending on the industry, the definition of inventory varies a little. A brief list of definitions follows:

All the goods, merchandise, and supplies a company keeps on hand in anticipation of selling them for a profit are referred to as inventory.

Example: Only the newspaper will be considered inventory if a newspaper vendor utilizes a vehicle to distribute newspapers to clients. The car will be considered an asset.

Inventory definition: A breakdown of terms- Inventory on the Balance Sheet

There are several commonalities between the definitions when we examine them all more closely:

As of inventory:

1. A tangible or intangible asset,

2. A resource that can be used to generate income or has a market worth; or

3. A work-in-progress asset that is intended for market sale

The manufacturing industry- Inventory on the Balance Sheet

Inventory at a manufacturing company includes raw materials utilized in production, semi-finished goods stored in warehouses or factory floors, and the finished product that has been manufactured and is available for sale.

An illustration would be a manufacturer of cookies. The inventory would consist of the packets of cookies that are ready to sell, the semi-finished stock of cookies that haven’t been cooled or packaged yet, the cookies set aside for quality control, and raw materials like sugar, milk, and flour.

The service industry- Inventory on the Balance Sheet

Since there is little exchange of physical stock in the service sector, the inventory is primarily of an intangible nature. Therefore, the process steps needed to complete a sale are typically included in the inventory for the service industry.

An inventory for a research consultancy company would be all the data gathered for a project. A vacant room is considered inventory by hotel owners.

What effect does inventory have on businesses?

For any manufacturing or trading company, inventory is a crucial asset. Thus business leaders must comprehend what it truly means. In addition to the general definition, some sectors of the economy, such as manufacturing and services, employ specialized purposes that consider all of the assets specific to those sectors. Business owners can better understand how their inventory serves them by understanding the many forms of inventory, including those that aren’t directly used in accounting.

A balance sheet is typically used by businesses to assess their financial assets and liabilities at a particular moment. Additionally, an inventory balance sheet shows how much cash your company has stashed away on its shelves or in storage when it comes to inventory.

Inventory accounting- Inventory on the Balance Sheet

Calculating the Inventory Balance

The amount of sales a company generates each period determines the ending inventory balance for that period.

The primary method for calculating ending inventory is:

Beginning Balance + Purchases – Cost of Goods Sold = Ending Inventory

Increased sales result in a greater cost of goods sold, which depletes the inventory account. The conceptual justification is that current assets, including raw materials, work-in-progress, and finished commodities, are converted into income. The cost of goods sold (COGS) account is how the cost of goods flows to the income statement.

In the revenue statement from the 3-Statement Modeling course at CFI, take note of the “Inventories” item.

Calculate the inventory turnover rate- Calculating the Inventory Balance

By finding your inventory turnover ratio, you can assess your inventory risk, particularly for spillage and obsolescence. Typically, it’s best to rotate your inventory as quickly as possible. Keeping inventory around for too long increases the likelihood that it will spoil or become outdated.

Remember that maintaining a meager inventory turnover ratio isn’t always feasible. Instead of comparing your turnover rate to companies in entirely different industries, you should compare it to your competitors.

The number of days the outstanding inventory- Calculating the Inventory Balance

Days inventory outstanding is a ratio that shows the specific number of days your business keeps stock before selling it to a customer. Once more, compare your ratio to companies in your industry rather than businesses in other industries.

A high days inventory outstanding calculation also suggests that your company’s inventory is a high-risk asset, just as a high inventory turnover ratio does.

A balance sheet inventory analysis method- Calculating the Inventory Balance

A balance sheet can show you how financially healthy your business is by balancing your company’s assets and liabilities. Additionally, by carefully examining inventory, your team can determine how liquid your stock is and how effectively your company uses or sells it.

In other words, your business can assess how risky your inventory situation is by looking at the inventory on your balance sheet.

What kinds of inventories are there?

Raw materials- Inventory on the Balance Sheet

Any material directly related to manufacturing completed goods but on which work has not yet started is considered a raw material inventory. Steel for a car maker is one instance.

All the elements processed to create the finished product are raw materials. Items like milk, sugar, and flour are examples of raw materials utilized in a cookie manufacturing company’s many stages of manufacture.

Understanding that raw materials utilized by a manufacturing organization can be acquired from a supplier or a by-product of a process is crucial when discussing raw materials. Most raw ingredients used in our cookie manufacturing business come from different sources.

On the other hand, a sugar-producing facility solely imports sugarcane from various farmers. Bagasse is the name for the leftover material after it has been treated in the factory to extract the juice. It is used as fuel, and the juice is transferred for boiling. Bagasse, juice, and sugarcane will all be used in this process as basic materials.

Only the manufacturing sector uses the idea of raw materials as inventory items. No raw materials are used in a trading industry because no processing or manufacturing is involved.

Work-in-progress- Inventory on the Balance Sheet

All units being produced that are only partially finished at any one time make up the work-in-progress inventory.

This phase is called “work in progress” when raw materials have been submitted for processing but have not yet been authorized as completed goods. After the raw materials have been processed and the cookies have been shaped, they undergo a quality check before being approved for final packaging in a cookie production facility.

All of the cookies that are awaiting quality control are regarded as incomplete. The things that have been processed but have not yet been sent for sale fall under the “work in progress” category, to put it simply.

Finished Goods- Inventory on the Balance Sheet

Inventory that has been constructed and offered for sale right away is referred to as finished goods inventory. Finished goods inventory comprises the cost of the raw materials, direct labor, and an overhead allocation regardless of the inventory cost method indicated above.

The final products prepared for market sale are known as finished goods. These products have completed all production and quality control steps. Therefore, the final cookie packets dispatched to the market for sale after passing through quality checks will be the finished goods for the cookie manufacturer.

A company’s financial statements divide the inventory into three primary categories: raw materials, semi-finished items, and finished goods. More sorts are kept around as a safety measure or for another reason.

Inventory and COGS- Inventory on the Balance Sheet

The cost of goods sold accounting approach also determines ending inventory. FIFO (“first in, first out”), LIFO (“last in, first out”), weighted average, and particular identification are the four primary techniques for calculating inventory. Each of these must meet specific requirements; depending on the country, some of these techniques may be illegal.

In an era of inflation, LIFO will result in a more significant cost of goods sold than FIFO. A smaller inventory balance would result from the LIFO approach than the FIFO method. This must be kept in mind when an analyst examines the inventory account.

Inventory MRO- Inventory on the Balance Sheet

MRO inventory, which stands for maintenance, repair, and operating supplies, is primarily essential to industrial sectors. MRO goods aren’t recorded as inventory in books of accounts, yet they’re crucial to how a business runs daily. The machines, tools, and other equipment utilized in production require maintenance, repair, and upkeep, which is accomplished with MRO supplies. Lubricants, coolants, uniforms and gloves, nuts, bolts, and screws are a few examples of MRO goods.

Buffer stock- Inventory on the Balance Sheet

It’s not always possible to forecast swings and market changes in a manufacturing or trade business. Such modifications may negatively affect the sales or production process, resulting in out-of-stock circumstances.

Buffer inventory makes an effort to make up for this by abiding with the proverb that prevention is preferable to cure. The commodities kept in a store or factory warehouse as buffer inventory, also known as safety stock, serve as a buffer against unforeseen shocks. If enough buffer inventory is kept on hand, an unexpected increase in demand, a holdup in transportation, or a labor stoppage can be managed.

Transit inventory- Inventory on the Balance Sheet

The term “transit inventory” describes things transferred between two locations, such as finished goods delivered to a store by truck or raw materials conveyed by train to a factory.

Cycle (or rotating) inventory- Inventory on the Balance Sheet

Items that are regularly ordered and in lot sizes are called cycle inventory. Materials directly used in production or a regular process element are typically included in cycle inventories.

Physical Inventory Controls Establishment- Inventory on the Balance Sheet

Protect your inventory. Implement receiving and shipping procedures, and restrict inventory supply access. Ensure that everyone who handles accounting entries and inventory control is familiar with stocked goods and objects.

When activities are shut down, storage rooms should be locked. High-value objects need to be locked up separately from the shared storage space. You should label and organize inventory to quickly access things and calculate the amount you have on hand. Sort out defective or obsolete products, make a note of them, and record them on a waste sheet.

Separating & Tracking Inventory- Inventory on the Balance Sheet

Several machines do the majority of manufacturing. A machine’s output is fed into the one after it for additional processing. All the machines must cooperate for the procedure to be successful.

Decoupling inventory is used when one of the pieces of equipment breaks down, which might cause the entire process to fail. Items maintained in reserve to be processed by a different machine if the first unit cannot provide its expected output are known as decoupling inventory.

The dough is formed and then baked in the oven in our hypothetical cookie-making scenario. The maker may save some additional pieces of molded dough that can be transported to the oven for baking while the machine is being repaired in case one of the molding machines breaks down and causes a delay in the baking process.

Receiving and Acquiring Items for Resale- Inventory on the Balance Sheet

Purchase orders are used to purchase items for resale (follow purchasing procedures). The packing/receiving slip should match the invoice and the materials you got when the goods are delivered. Adjust the Inventory object code to reflect the products and invoices that have been received.

Inventory purchases are recorded as a charge (debit – D) in the sales operating account on an Inventory object code.

Keeping track of sales transactions for goods- Inventory on the Balance Sheet

Ensure that the correct things are billed to clients and shipped to them when goods are sold and that all transactions are appropriately recorded. Enter sales data into the sales operational account with the proper sales object code. Using a cost of goods sold transaction, move the inventory cost of goods sold to the operating account.

Understanding and Keeping Track of the Cost of Goods Sold- Inventory on the Balance Sheet

The value (cost) of what you sold is known as the cost of goods sold and is determined as follows:

Cost of goods sold = Beginning Inventory + Purchases – Ending Inventory

Profit is computed as follows: Sales less costs equals profit.

Gross Profit = Sales – Cost of Goods Sold

These calculations must be performed over the same time frame. The computations can be performed weekly, monthly, quarterly, or annually depending on the number of your transactions. All transactions must be finished by June 30, though.

Reducing (C) the Inventory object code for sold goods and charging (D) the Cost of Goods Sold object code in the operating account will reflect the cost of goods sold.

Physical Inventory Procedures- Inventory on the Balance Sheet

Every year, a physical inventory must be completed. A thorough physical inventory is crucial to producing an accurate, consolidated balance sheet at the university level.

The outcomes of the physical inventory directly impact the unit’s cost of products sold, revenue, and profit, and subsequently, on the data displayed on the university’s financial statements.

1. Stop shipping and receiving while taking a physical inventory.

2. Make counts using inventory tracking sheets.

3. At least two people should perform the physical inventory. Spot-checking completed, a third party can do inventory sheets.

4. Items with a count of 0 should be included.

5. Items sold but not sent, received but not documented, or obsolete or damaged should not be included.

6. To avoid counting the same thing twice, mark the objects as you count them.

Record the adjustment entries in the general ledger after completing a physical inventory. Keep a digital copy of the physical and finished physical inventory reconciliations on hand for internal and/or external auditors.

Changing the Inventory Balance in the General Ledger

Adjust the general ledger inventory balance to the physical “actual” balance following each physical inventory. Your inventory monitoring system should monitor the balance in the inventory book.

Recognize inventory risks- Inventory Balance in the General Ledger

Your business can use balance sheets to identify financial risks such as shrinkage, spoilage, and obsolescence. You must review your inventory reports with your team to assess risk since your balance sheet does not explicitly mention inventory risks.

1st risk: shrinkage- Inventory Risks

Inventory shrinkage, which refers to theft or shoplifting of inventory, is a significant concern for many retail establishments. A risk reduction strategy may be appropriate if your company has substantial cash locked up in inventory.

Resolving Stock Shortages- Inventory Risks

When there are fewer things on hand than what your records show, or when you have not charged enough to the operating account through the cost of goods sold, you have an inventory shortage.

Reduce the balance on the Inventory object code (C) and increase the Inventory Over/Short object code (D) in the sales operating account to fix a shortage.

To lessen the likelihood of an inventory shortage, take into account the following:

1. What happened to lower the value of the physical inventory than the book inventory?

2. Was the worth of the things less than what was documented when they were received or recorded?

3. Was the value of the products higher than what was documented when they were sold or shipped?

4. Is there a possibility that employee theft contributed to the error?

2nd risk: Spoilage- Inventory Risks

Inventory spoilage occurs when a product degrades before a business can sell it. A risk of having too much inventory exists if your business manufactures or sells perishable goods, such as food or medicine. While some spoilage is accounted for by the cost of the goods sold, unusual or careless spoilage is a significant concern.

Preventing Inventory Overages- Inventory Risks

This is known as inventory overage when you have overcharged the operating account for the cost of goods sold and have more inventory on hand than your records show.

To remedy an overage, lower (C) the Inventory Over/Short object code in the sales operating account and raise (D) the balance on the Inventory object code.

To lessen the likelihood of an inventory overage, take into account the following:

1. Why is the physical inventory worth higher than the book inventory, and what changed?

2. Was the worth of the things larger than documented when they were received or recorded?

3. Was the value of the products less than recorded when they were sold or shipped?

Inventory Devaluation Recording

Depreciation of inventory increases (D) the Cost of Items Sold object code in the sales operating account while decreasing (C) the Inventory object code for depreciation of goods not sold over time.

3rd risk: inventory obsolescence

Inventory obsolescence occurs when your inventory is out-of-date, drastically reducing or eliminating its value. This may happen when a product is released at the right time or when new, improved product versions are available. Televisions, phone cases, and Christmas sweaters are a few examples.

It would help if you ascertained how much inventory you have and its value after deciding which inventory is the current asset inventory. There are numerous methods for doing this, including:

How inventory software reduces risk and saves time

Software for inventory management can organize your business and make it more aware of its inventory. Beyond that, though, the right inventory app can assist your company in automating and streamlining many inventory-related balance sheet tasks, such as maintaining inventory levels and designating items as current assets (inventory) or long-term assets.

You’ll be able to determine your inventory turnover ratio quickly, view all of your assets in one location, and make knowledgeable decisions regarding risk mitigation if you have a firm grasp of what you have.

Carrying out an inventory count by hand- How inventory software reduces risk and saves time

You might have to stop operations and conduct a physical inventory count if you don’t have access to up-to-date inventory data. You might think about uploading information to a perpetual inventory system as you carry out your count. In the future, obtaining the information you require to evaluate your inventory whenever you need, it will be simpler.

Some companies count and evaluate their inventory at the end of each quarter or each year.

Periodic and Perpetual Inventory Systems- How inventory software reduces risk and saves time

The account’s value on the balance sheet is influenced by the type of accounting system utilized. While perpetual systems calculate the inventory value after each transaction, periodic inventory systems determine the LIFO, FIFO, or weighted average value at the end of each period.

Using a different system will produce a different value because of the varied time frames and potential for different costs. Analysts must consider this distinction when assessing businesses with various inventory management systems.

Turnover and Accounts Payable- How inventory software reduces risk and saves time

The average inventory balance across two periods must be known to calculate the turnover ratio and establish the typical number of days needed for inventory turnover. In these computations, the numerator can be either net sales or cost of goods sold. However, the latter is typically preferred because it more accurately reflects the value of the raw materials, works-in-progress, and finished things available for sale.

The value of purchases must be the numerator for accounts payable turnover. Since purchases of raw materials and work-in-progress may be made on credit, this indirectly connects to the inventory account and affects the accounts payable account.

Establishing an Inventory Tracking System- How inventory software reduces risk and saves time

In general, units should have an inventory accounting system that keeps track of inventory purchases and sales and enables units to determine the cost of goods sold, which must be transferred to the operating account.

Sales are recorded on the operating account with the appropriate sales object code, and inventory purchases are recorded on the operating account with an inventory object code. The cost of goods sold is transferred to the operating account through a cost-of-goods-sold transaction.

Making use of inventory management tools

What is a quick method for inventory and asset evaluation and sorting? Create reports for each term after classifying each item in your inventory as an “inventory” or “long-term asset” using an inventory app like Sortly.

You can instantly run a report showing how much of each item you have, whether a current or long-term asset and its cash value as long as you’ve added item details to your software.

Inventory & the Income Statement

Inventory Reporting on Financial Statements

A company’s present assets are listed in the asset area of the balance sheet as inventory, which is an asset. Inventory is not a line item on the income statement.

The Cost of Goods Sold, frequently shown on a company’s income statement, is calculated using the change in inventory as one of its constituents.

To calculate a company’s cost of goods sold, an increase in inventory will be deducted from purchases of goods, and a decrease in inventory will be added to purchases of goods.

[Some income statements will reflect the computation of Cost of Goods Sold as Beginning Inventory + Net Purchases = Goods Available – Ending Inventory] rather than just displaying the change in inventory as an adjustment to the cost of goods.]

An example of presenting the calculation of the cost of goods sold

Assume that a business has $100 in inventory at the start and $110 at the end, an increase of 10. Let’s say a business spent $1,000 on purchases throughout the accounting period. The following formula is a typical way to show the cost of goods sold computation on the income statement: $1,000 in purchases minus a $10 increase in inventory equals $990.

This computation of the cost of products sold on an income statement is frequently found in textbooks: $100 in initial inventory plus $1,000 in purchases equals $1,100 in cost of goods available less $110 in final inventory equals $990. As a result, the cost of products sold in both presentations is $990.

Valuing Inventory on the Balance Sheet

Companies typically use one of two methods to measure the value of their inventory: cost or market.

The cost method assigns a cost to each item in the inventory, typically based on its purchase price. This method is ideal when estimating inventory value as it considers depreciation and other expenses associated with acquiring the inventory. The cost method also provides a reliable estimate of what it would cost to replace the items in the inventory.

The market method values each item in the inventory at its current market price. This method is useful when a company’s inventory contains items that have increased in value since purchase, such as inflation-sensitive commodities or rare antiques. The disadvantage of this approach is that it does not reflect any additional costs associated with acquiring the inventory.

Companies need to choose an appropriate inventory valuation method for their balance sheet. The choice of method will affect the accuracy of the financial statements and any decisions made based on those statements. It is also important to note that inventory must be accurately reported at least once a year to comply with legal requirements.

The importance of accurately valuing inventory cannot be overstated. Businesses need to understand how to accurately value their inventory to ensure that their balance sheet is accurate and that they comply with legal requirements. By understanding the different inventory valuation methods, companies can ensure that their financial statements reflect the true value of their inventory. This will help them make better decisions and provide reliable financial statements to investors, creditors, and other stakeholders.

Recap- Inventory on the balance sheet

Inventory is an essential asset on a company’s balance sheet. It consists of the goods and materials a business owns, ready to sell or use in production. Inventory can include raw materials, work-in-progress (goods partially through the production cycle), and finished products. It is listed as a current asset on the balance sheet.

Inventory is a key component of the current assets section of a balance sheet. Since inventory is an asset that can be converted into cash quickly, it is important to accurately show its value on the balance sheet.

Inventory on the Balance Sheet- Recommended Reading

1. What Is an Inventory Bin Card? Should I Use Them?

2. What Are The Inventory Valuation Methods Used In Business?

3. Everything You Need to Know About Inventory: Accounting, Reporting and Costing Methods

4. Inventory Accounting- Why It Matters and How to Calculate 

5. Which Costs Are Included In The Finished Goods Inventory Under Variable Costing?

6. Standard Cost Inventory – Comprehensive Strengths & Weaknesses

Updated:4/13/2033