All About Inventory Valuation for Business

Small-scale businesses transform into huge giants with the help of this. What is this? It is nothing but knowing what comes in and understanding what goes out. In simple terms, inventory valuation means a procedure of accounting for the true value of the said business’ inventory. It is a process of keeping a track of what raw materials are required to make the finished product and what is sold off to customers. For example, a fashion design studio would have cloth, bows, buttons, and threads as raw materials inventory. Additionally, the studio would consider stitched garments as sales inventory ready to be purchased by the clients.

Any inventory is expensive for a business, and operating with minimal inventory often turns profitable for businesses. Many times inventories need more place to hold them. Thus, investing in spaces has to be considered by businesses. They also have a feature of losing value with time and can depreciate too. For example, if you own a mobile shop, you might feel the need to sell off all the mobiles as soon as possible to prevent them from becoming outdated. As obsolescence enters in, you will need to sell off the outdated mobiles at a discounted rate or with some offers to create space for newer ones.

Objectives of Inventory Valuation

In business, inventory refers to goods up for sale or unsold ones. In manufacturing industries, it includes raw materials, semi-finished, and finished goods. The inventory valuation is done at the end of every year to understand the cost value of goods sold and unsold. Knowing this a businessperson can understand whether the business is making profits or is at loss.

Ascertain the Gross Income

Inventory valuation helps to understand the gross profit, i.e., the excess of sale over the cost of goods sold. To simplify this here’s a formula to get the correct cost of all the goods sold.

Opening stock + Purchase of stock - Closing stock = Cost of sold goods

The above formula shows clearly that the inventory affects the cost price, therefore profit ratio too. Also, to track the financial transactions in the business, one can download and use the OkCredit app. It helps monitor the financial inflow and outflow. The app records all the reports and statements, and they are downloadable too. And more than anything else, it keeps all data 100% safe and secure.

Determining the Financial State

The closing stock will be considered a current asset. Thus the valuation of current stock on the balance sheet specifies the actual financial condition of a business. Undervaluation and Overvaluation can give a blurred picture of the exact state of the financial position and working capital position of the business.

To understand this further, let’s know how we can calculate inventory values?

The inventory value can be calculated by multiplying the units in hand with the cost of each unit. According to this method, we have two main inventory valuation methods.

Item wise Method

In this method, the units are calculated item-by-item. We must consider the lower cost price or market price for assessing this method. For example, you can study the table given below to make the process clear. We’ll consider mobiles as an item.

Considering this example, the total inventory value will be 1,78,000,000. Once you have identified the lowest price of the two, it becomes easier to calculate the total inventory value.

Category Method

In this method, one can club the items based on their categories and then calculate the total inventory value.  

Let’s see the same example of mobiles for the category method.

Using this category method, we obtain an inventory value of 2,80,000,000.

Specific Identity

Using this method, one needs to track an item from the time it has been stocked to the time it is sold. This method is usually used for large items that can be visibly identified. The segregation can be done on the RFID tag, receipt stamped date, or a specific serial number allotted. The identification method introduces a high level of accuracy to the inventory valuation process. But this method is restricted to high-value and rare items where such identification is needed.

First In, First Out (FIFO)

Valuation of inventory is strategically sorted with this method. It is one of the widely used methods for calculating inventory value. This method signifies the first product purchased on the premises is the first to be sold. The FIFO method is widely used around the globe, as it is one of the simplest methods and can be easily understood. At the time of inflation, the FIFO method holds a higher inventory value, the cost of goods lowers, yielding a higher profit. But when there is rapid movement in prices, it fails to generate accuracy in results.

Last In, First Out (LIFO)

Under this inventory, the last product that enters the premises is sold first. The LIFO method is rarely used in business as the newer products keep moving out keeping the older stocks as it is. It results in significant losses in the older stockpiling up and losing its value.

Average Weighted Costing

Under this, the following formula is used to generate the inventory value of goods.

Average Weighted Cost Per Item = Total Cost of Goods in Inventory / Total Items in Inventory

This method is used when the items are indistinguishable from each other, and it is tough to note down their costs.

Conclusion

While investing your time and effort in the inventory valuation, you will need good HR software to take care of the human resource working in the company. And that can be easily handled by using the OkStaff app. For it is rightly said, the human resource is the backbone of every business, and all other departments depend on HR.

A business can consider any method to evaluate the inventory. But once a method is selected, changing isn’t possible as it disturbs calculations and the balance sheet. Thus, one must first gain complete knowledge about the inventory valuation and then select the method to determine it. Needless to say, inventory valuation must be executed every year to understand the profit scale of the business. This gives a clearer picture to a business about planning the next year dynamically without facing losses.

Also Read:

1) Why You Should Have A Joint or Independent Account With Your Business Partner?
2) 4 Tips for Improving Customer Service
3) Want To Earn Income From Investment Without Paying Tax? Try Tax-Free Bonds
4) Things Business Owners Should Do If They Can’t Pay Credit Card Bills

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FAQs

Q. What are the main four methods of inventory valuation?

Ans. Most businesses choose one of the specific identifications, average weighted, FIFO, and LIFO methods to determine the inventory value every year. The most commonly used method is FIFO.

Q. What is the best inventory method?

Ans. Out of all the best and the most widely used is the First In, First Out - FIFO method. This method justifies the inventory valuation properly without having to face huge losses.

Q. How do you choose the best inventory valuation method?

Ans. While picking the best inventory valuation method, you need to pick a few elements. First, you should determine the cash implications and ascertain what cash flow might look like in the next two to five years. Second, understand the impacts on your financial records. By analysing these elements, you will be able to decide the best option for your business.

Q. How is inventory valued in accounting?

Ans. Inventory valuation is the cost associated with a business’s inventory at the end of a financial year. The inventory valuation is based on the costs incurred by the entity to get the inventory, transform it into a product that makes it ready for sale, and have it transported into the proper places for carrying out sales.