- business

The Need For Inventory in a Business

Inventory is a tricky business activity because you could potentially end up spending your entire vacation completing the task. You might also have to visit a client’s workplace to sort out your inventory.

The main question here is why do businesses carry out this function or have to do inventory? Especially at the end of the year…

The main reason why a business must invest time, money and efforts into inventory is because it boosts sales. Discussed below are some of the basic questions which you must find answers to before you get started with your inventory process.

 Manage Business Inventory

The best way to manage inventory is by understanding why it needs to be carried out in the first place. Inventory is an asset to the business and the sole purpose of carrying out this process is to manage all of the business’s important assets.

Inventory helps you to determine all the assets owned by your business. This way, you do not run short of a particular product or store it in excess. There are two methods which businesses adopt, to manage inventory- periodic and perpetual.

Most owners prefer a periodic system especially if they are operating in the retail market. In the periodic system, owners can keep a track of their assets by counting them, right at the start and end of a specific tenure.

 Value of our Inventory

In any company, the value of inventory is based on the valuation criteria it implements- First In-First out (FIFO), Average cost or Last In-First out (LIFO). The valuation method can have a huge impact on your taxes as there are many tax norms related to your inventory value.

For instance, the FIFO method calculates inventory by assuming that items which enter inventory first gets sold first (irrespective of the actual sale day). On the other hand, LIFO valuation assumes that goods that walk-in last in the inventory are sold first.

Average cost is calculated by taking an average of the cost of all the sold items in a particular period. It is just as the name suggests-‘average cost’. Selection of the method mainly depends on the nature of your business and potential tax implications.

It is important to choose an appropriate calculation method so that you can maintain basic cash flow. In order to find out more about cash flow finance you can seek assistance from reputable and experienced finance professionals.

They can identify your business’s needs and suggest to you a suitable business plan that can provide your business with long term steady cash flow.

Inventory Turnover

Inventory turnover indicates the number of times your inventory turns over (sold or replaced) in a year. Inventory turnover basically measures the efficiency of a business. How good a business is in managing and selling its inventory?

The ratio of turnover is directly proportional to sales and business. This means that higher turnover means higher sales and higher business efficiency.

 Inventory for Cost Of Goods Sold (COGS)

Most business owners find it tricky to calculate cost of goods sold, irrespective of whether they sell, manufacture, and re-sell or purchase those goods. Entrepreneurs must take into account the fact that the cost of goods sold is the cost of doing business.

The simplest and the best way to calculate cost of goods sold (especially for tax return) is to note value of items at the beginning and the end of the inventory process. If the product is sold at a higher cost then the business will earn a lower income.

 Let’s make your understanding simpler with help of this example-

If you own a chocolate business which makes chocolates and sells chocolate boxes then your inventory includes chocolate boxes ready to be delivered, chocolates that have been prepared but not boxed, melted chocolates and other raw materials used in the process.

In simple terms, taking inventory is to stop work on a particular day/date and count everything. The process of counting is quicker and simpler for small companies. But, it can be tiresome for large companies as they have many products and complex parts utilised in the process.

Such companies generally prefer spot-check or sample techniques. Counting every single small unit of the huge product can be time-consuming and hence sample check is preferred to get an estimate of the inventory.

But, one hurdle that every entrepreneur has come across during this process is that of missing inventory. The best way to avoid this situation is to carry out a physical inventory evaluation but this might not be possible for some businesses considering its diverse and huge nature.

There are few common reasons which lead to missing inventory and they are-

  • You might have discarded some damaged/unusable inventory
  • Inaccurate record of inventories might result in confusion of whether some inventory is missing.
  • Inventory which had become obsolete and thus discarded which results in missing inventory
  • Employee theft can be yet another reason for missing inventory

It is therefore essential to keep track of all the items that enter or exit your business so that you have a clear idea about all the assets that belong to you.