Inventory accounting and why it’s important

 In this blog post, you will learn:

1. What is inventory accounting?
2. Why is it important for businesses to track their stock levels
3. The different methods of inventory tracking
4. Calculating the cost of goods sold and how it impacts profit margins
5. The benefits of an inventory management system
6. Tips for streamlining your inventory tracking process

What is inventory accounting?

Inventory is also known as stock and it is the accounting term for the goods you have purchased (raw materials), work-in-progress products and finished items that are not yet sold. Inventory is usually recorded as a current asset in your business balance sheet which will turn into revenue in the near future. 

Why is accounting for inventory important?

Inventory items at any of the three production stages can change in value. This could be for a wide variety of reasons including change in consumer demand, product obsolescence, product aging, change in market supply. It is vital to have an accurate valuation of inventory to ensure that the balance sheet reflects the company assets correctly and this can be achieved using an inventory management system.

The different methods of inventory tracking

Inventory tracking is the process of keeping track of the inventory of a business. There are a few different methods that businesses can use to track their inventory. The first method is called first in, first out (FIFO). With this method, the inventory that is purchased or produced first is also the inventory that is sold first. The second method is called last in, first out (LIFO). With this method, the inventory that is purchased or produced last is the inventory that is sold first. The third and most common method is called average cost. With this method, businesses keep track of the average cost of their inventory and use that number to calculate their profits. The average cost method uses the weighted-average of all inventory purchased or produced in a period to assign value to cost of goods sold (COGS) as well as the cost of goods still available for sale. No matter which method is used, inventory tracking is an essential part of running a successful business.

Calculating the cost of goods sold and how it impacts profit margins

The cost of goods sold (COGS) is a key metric for businesses and is used to calculate the company's profit margins. COGS includes the cost of materials, labour, and other direct expenses associated with the production of goods. It excludes indirect expenses such as marketing, shipping, and administrative costs. Because COGS is subtracted from revenue to calculate profit, it has a direct impact on profit margins. A higher COGS results in lower profit margins. The COGS will be impacted by the method that you choose for valuing inventory. Accounting standards require that businesses adopt a consistent approach from period to period for inventory accounting. 

The benefit of an inventory management system

There are several benefits of implementing an inventory tracking system, aside from helping to meet accounting standards compliance. These include:

• More accurate valuation of your stock leading to better business decision making
• Automation of stock management may enable a business to reallocate staff leading to greater productivity 
• Reduced costs – when your business has a better understanding of stock levels, you can reduce overstocking, leading to reduced storage costs without impacting supply to your customer
• Better customer experience – a business that knows its stock levels at all times can create a better ordering and shipping process which leads to customer retention and repeat sales.

Tips for streamlining your inventory tracking processes

Inventory tracking is a critical part of any business, but it can be a time-consuming and expensive process. There are a few simple steps you can take to streamline your inventory tracking and reduce costs:

1. Automate data entry wherever possible. This can save a lot of time and reduce errors.
2. Use barcodes or RFID tags to track inventory. This can make it easier and faster to scan items and keep track of inventory levels.
3. If you make perishables, manage your inventory by production date to ensure you sell the oldest stock first.
4. Integrate your inventory tracking system with your other business systems, such as your accounting software. This will save time, reduce inconsistency errors and duplication and ensure that all your data is in one place.
5. Review your inventory regularly to pick up any discrepancies as early as possible.

Businesses can struggle with cashflow if they don’t have a good handle on their inventory accounting. Get in touch with David Masih, our client relationship partner. David can explain how we can support you to achieve a streamlined stock management system, during a no-obligation chat today. Call 03330 067 123 or email info@onthegoaccountants.co.uk.