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Is Your Inventory a Liability?

Don’t let your inventory go from an asset to a liability. What you don't know (or do) can hurt your bottom line.

Having inventory that can be sold quickly for cash (i.e. liquid assets) is important. But if you can't offload that overstock of $100k items, it won’t matter unless there’s a need for them.

So while inventory is one of the primary sources of revenue for the business, it can also be a huge liability. While growing businesses typically focus on inventory management (the process of ordering, storing, and using a company's inventory), they may not give as much attention to how they account for it.

How to Protect Inventory as an Asset

Depending on your product, it may carry the risk of spoilage, damage, or theft. It also carries the costs associated with storage, insurance, shifting demand, seasonality, mis-shipments, overstock, and other factors. What was once intended to provide an economic benefit can quickly become a source of financial deficit.

For these reasons, inventory management coupled with inventory accounting is important for businesses of any size. An asset account can help you keep track of when to sell or restock inventory, how much inventory to purchase or produce, what price to pay when to sell, and at what price.

To gain a competitive edge, companies need to have efficient and effective inventory accounting and management strategies. If neglected, inventory can quickly change from a company asset to an unwanted liability.

Fortunately, a good fractional CFO or financial consultant can provide clear financials and make these decisions easier. We have some tips below to get you started.

What is Inventory Accounting?

Inventory accounting helps determine the economic value and costs of maintaining inventory. Outside of the obvious, this data is valuable for setting competitive pricing, getting insured, budgeting, optimizing your supply chain, calculating accurate taxes, selling your business, and more.

But the value of raw materials and finished goods can change over time, which makes keeping track of your inventory a significant challenge.

This is where clear, accurate accounting and financial management can lend a hand.

Inventory Accounting Methods

There are several common ways to account for inventory. Choose the inventory accounting method that’s best equipped to maximize your revenue potential, including tax liability.

  • FIFO (first in/first out) – This method assumes that the items purchased or manufactured first are used or sold first, so the items remaining in stock are the newest ones.
  • LIFO (last in/ last out) – This method assumes that items purchased or manufactured last are sold first, so the items remaining in stock are the oldest.
  • Weighted average – This accounting method opts to average out the total cost of items available for sale against the number of units in inventory or purchased. Typically, this average is computed at the end of an accounting period.

Key financial and operational decisions are made based on the information in these financial statements, forecasts, and projections. Some of these decisions can help you manage shortfalls and overcome industry-wide obstacles. Properly accounting for automotive inventory, whether by FIFO, LIFO, weighted average, or another method plays a vital role in ensuring an enterprise's short and long-term success.

Related reading: Taming the Beast That is Financial Reporting

How a CFO can help with inventory management

Inventory is the lifeblood of most businesses. It’s critical to know what products you have on hand, how much each product is worth, how to budget for it, and how to predict demand.

Consider the benefits of a financial pro or outsourced CFO:

  • Accounting for the inventory directly impacts profit and taxation.
  • Accurate data and inventory planning help lower the costs of keeping items in stock.
  • Clear accounting can minimize risk as well as make it easier to predict and shift with changes in demand.
  • Management isn't just about the finished product; it also accounts for a company's cash flow, labor, and overall assets.

Proper inventory management and accounting can keep a business running smoothly as well as reduce costs, improve cash flow, and boost the business's bottom line. 

Need help to figure out if you have excess inventory on hand at your company? Contact us for a free consultation today. We’ll help to ensure that no current asset becomes a liability. 

Learn More About Inventory Production

Every business owner knows just how chaotic it can be to manage finances and make strategic business decisions. Am I making payroll? How many current assets do we have? What are our liabilities?

Thankfully, answers to all these questions can be found in your company’s balance sheet and with the help of our free cash flow template. Learn why it’s important for business owners and their accountants to understand their financial data—and how that brings them the freedom they need to grow their business operations.

If you don't have a team or you just need to supplement your existing team, try hiring an outsourced CFO. Our fractional financial experts can work as your virtual CFO or in coordination with your financial department to ensure that your reporting, inventory, and strategy are aligned.