How Inventory Management Affects Your Financial Statements

Posted by Janis Narvas

Aug 2, 2019 12:00:00 PM


Inventory management is one of the tasks that business owners should prioritize. You can use a small business inventory software to take stock of your inventory or if you’re not yet ready for automation, you can also use a simple stock book or Excel spreadsheet. But why is it an important step in your accounting process?

Related: Introduction to Company Financial Statements

Managing your inventory is a crucial activity for any small business owner in Australia. Having a low inventory level can be a cause of delay for your product delivery, while having too much stock in excess can adversely affect your cash flow.

manager using a small business inventory software

Definition of Inventory Management

Inventory refers to the goods and materials that your business owns in the form of raw materials, components, and finished products which are held for the purpose of resale to a customer.

Inventory management, on the other hand, refers to the process by which non-capital assets (i.e., raw materials and finished goods – inventory) are obtained, stored, and used by a business.

Inventory Management and Your Financial Statement

How exactly does having a good inventory management process affect your bookkeeping? We review some ways by which proper inventory management can affect your financial statements.

1. Your Profit and Losses

When errors are committed in calculating inventory, your income, cost of goods sold (COGS), and profits will be affected. Some reasons why your inventory might be inaccurate are as follows:

  • There might be some damage to your goods during transit;
  • Returned goods might not have been added back to the inventory; or
  • There may be old goods that have been sold at a less price.

To get an accurate value for your profits and losses, you will need to review your inventory.

Valuation method2. Your Valuation Method

Costing Methods to Account for Inventory

There are different costing methods for inventory. The method that you choose for valuing your inventory will be included in your financial statement as the inventory footnote. Here are the four most common costing methods:

  • First In, First Out (FIFO)
  • Weighted Average Method
  • Last In, First Out (LIFO)
  • Specific Identification Method

Among these methods, the FIFO method can yield a higher gross profit, higher ending inventory, and lower cost of goods sold (COGS), thus leading to a higher taxable income. Conversely, the LIFO method will yield a lower gross profit, lower ending inventory, and higher COGS, thereby leading to a lower taxable income.

3. Accurate Valuation of Assets

The total current assets, total asset balances, and the actual inventory in your financial statements would be dependent on the valuation method that you choose. Therefore, it’s important that you stick to a single method to be applied consistently in your financial reporting to maintain accuracy and meet compliance requirements.

Read Next: Accounting Financial Statements for Franchises in Australia

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Topics: Financial Management and Analysis

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