When it comes to accounting in the world of assets one thing to be understood is inventory accounting. The inventory account is dealing with values and accounts that are associated with inventory assets. As an example, if we look at a manufacturing business, they will have inventory accounting locked in place to keep tabs on raw goods, in-progress goods, and goods that are finished. This allows a team to assign values to these assets to record and process them in accounts which will show investors, managers, and board members where their current inventory levels are sitting. There are a lot of benefits outside of the business for investors but as a team running a company for growth, this allows them to keep tabs on what is needed to keep producing their goods evidentially and without delays. It also allows for a complete valuation of a company worth as these are still considered assets regardless if they are raw goods or produced goods.
How Does Inventory Accounting Work in the World of Business?
Inventory accounting works in a sense to show overstating profits compared to understanding inventory values. This allows for correct values when it comes to company valuations as investors but also allows for correct forecasting internally for the cost of goods compared to profits being drawn from sales. Some companies will show larger profits compared to current inventory levels to overstate their value resulting in a higher valuation when it comes to an EPS breakdown, but the GAAP has set regulations in place to disallow companies from doing this. In the sense of accounting, this allows for accurate allowances for current inventory levels to develop plans to either up production of a good or decrease production to match that of current demands resulting in higher profits and discounts on accounts payable.
What Are the Advantages of Inventory Accounting?
As mentioned above, the key advantage to having an inventory account is to show the correct financial health analysis of a company. This is the main benefit for investors and growth in funding but internally the biggest advantage would be understanding current levels of inventory when it comes to forecasting for long-term growth. This opens a realm of viewing current profit margins based on the cost of goods to profits from sold goods and unearth areas of opportunities to cut costs for profit boosts.
This type of approach to inventory accounting is something that is mostly seen in the manufacturing world but even smaller companies that aren’t public can still utilize the use of inventory accounting. Again, the main advantage of inventory accounting is to understand potential profit growths. It also allows for correct levels of stock when it comes to buying products for reselling which can allow for correct inventory levels to meet that local demand.
Four Steps to Inventory Accounting
Now that we understand inventory accounting and why it is important for both publicly traded companies and small businesses, we need to discuss a way to start inventory accounts on a small business level.
- Determine Unit Counts After Production – This is the step that requires knowledge of production or customer buying needs. When accounting for inventory, one needs to understand what materials are needed to either build a product or sell a product (shows at the finish line is inventory and the quantity needed is the amount requested from the buyers). The easiest way on the manufacturing end is to see how many units are needed at the end of production and then find how many raw materials are needed to make that select amount of product.
- Physical Counts – This is one of the most crucial aspects of inventory accounting and usually is the most tedious. There will need to be an individual that keeps count either physically or systematically of inventory levels to report back to the correct accounts to show what is currently in stock versus what is needed to produce the goods needed.
- Estimate Ending Inventories – This is where having current inventory levels accurate can allow for future forecasting of finished products. If the math is correct when it comes to inventory levels, then one will be able to forecast future sales based on what they currently have in stock. This rule goes hand in hand with Rule 1.
- Assigning Costs to Material in Inventory – Once the quantities are accounted for then there needs to be a monetary amount associated with each product in inventory to correctly forecast the cost of goods versus future profits from finished products.
In conclusion, there are a lot of reasons to implement inventory accounting regardless of business size or personal needs. It allows for an accurate representation of current inventory levels compared to finished goods, but it also tracks estimated profits before the sales are made resulting incorrect forecasting for inventory needed for business growth.