Inventory value

From CEOpedia | Management online

Inventory value is a value of tangible personal property held for sale in the usual course of business, in the process of production for such sale, or to be used currently in the production of items for sale[1].

Inventory is an asset that is difficult to control - it arrives and departs company premises daily, is scattered throughout the warehouse and production areas (and possibly off-site storage locations), may contain obsolete or scrap items, can include thousands of part numbers and also can include items owned by suppliers or clients, and it may be valued using a variety of methods for both direct and overhead costs. It is used control systems to make I less likely that the units and costs associated with inventory are incorrect[2].

Control Over Inventory Value

One way of keeping control over inventory value is to balance the values of input and output. If the value of the input is kept to below the value of output, then stock decreases. The value of supplier deliveries should be smaller than the forecast value of consumer dispatches in each time period. Supplier deliveries are a consequence of the purchase order and schedule commitment, so it is the ordering process that has to be kept under budgetary control. The control process relies on gathering information on [3]:

  • the forecast value of demand for each time period (week or month)
  • the amount of schedule or order commitment already made for delivery in each time period
  • the standard value of last-minute (emergency) orders which are committed each time period

A system on stock reduction, or increase, has also to be defined in terms of what value change in inventory level is considered practical or helpful each time period. From this information it is easy to estimate:

  • The maximum delivery value for every time period
  • The maximum value of order commitment for delivery per period
  • The maximum value available for new orders set for delivery during that period

This maximum value obtainable for new orders is the ceiling for total order value for delivery in the time period. If this value is exceeded by placing a further supply order, then that order should be rescheduled into a later time period (or another order delayed) or otherwise, the resulting stock value will increase[4].

Application of Inventory Value

Inventory is expensive and it equals up working capital. Furthermore, inventory requires storage space and incurs other carrying costs. Some products such as perishable food items and hazardous materials (hazmat) require special handling and storage that add to the cost of holding inventory. Inventory can also worsen quickly while it is in storage. Additionally, inventory can become obsolete very promptly as new materials and technologies are being added. And the important thing is that large piles of inventory delay a firm's ability to react swiftly to production difficulties and changes in technology and market conditions.

Inventory investment can be estimated in various ways. The typical annual physical stock counts to discover the total dollars invested in inventory provides an absolute measure of inventory investment. Then The inventory value is recorded on a firm's balance sheet. This value can be handled to compare the budget and past inventory investment. Nevertheless, the absolute dollars invested in inventory does not provide a sufficient sign concerning whether the company is using its inventory intelligently.

The inventory turnover ratio (or inventory turnovers) is widely used to measure to analyze how efficiently a firm uses its inventory to generate revenue. This ratio determines how many times a company turns over its inventory in an accounting period. Faster turnovers are regularly observed as a positive trend because it indicates that the company is able to create more revenue per dollar in inventory investment. Further, faster turnovers allow the company to improve cash flow and decrease warehousing and carting costs. Conversely, a low inventory turnover may show to overstocking or deficiencies in the product line or marketing effort[5].

Examples of Inventory value

  • Raw materials: Raw materials are the basic materials used in the production of goods or services. Examples of raw materials include steel, timber, oil, and grains.
  • Work in progress: Work in progress (WIP) refers to partially completed products that are still in the production process. Examples of WIP include partially assembled cars and partially completed garments.
  • Finished goods: Finished goods are products that have been fully completed and are ready for sale. Examples of finished goods include finished cars, clothes, and electronics.
  • Supplies: Supplies are items used in the production of goods and services, but are not part of the finished product. Examples of supplies include tools, packaging materials, and cleaning supplies.

Advantages of Inventory value

Inventory value plays an important role in business operations. It provides a snapshot of a company’s assets and can help with business decision-making. Here are the key advantages of inventory value:

  • Knowing the value of inventory helps a business to manage its cash flow, as it can use the value of inventory to determine how much it needs to pay for goods and services.
  • It provides an indication of a company’s profitability, as profits are directly related to the value of its inventory.
  • It also allows a business to effectively track the performance of its products and services, enabling better inventory management and pricing decisions.
  • By keeping track of inventory value, a business can identify trends and opportunities in the marketplace, such as increased demand for certain products or services.
  • Inventory value also helps to identify areas where cost savings can be made, such as reducing the number of slow-moving products or services.

Limitations of Inventory value

Inventory value is a value of tangible personal property held for sale, in the process of production for such sale, or to be used currently in the production of items for sale. However, there are several limitations to inventory value that should be taken into consideration, including:

  • The value of inventory held for sale may not be accurate due to the changing market conditions and fluctuations in prices.
  • The cost of production and other related expenses may not be taken into account, leading to an inaccurate value of inventory.
  • Consumer trends and preferences may not be reflected in the inventory value as it is based on current market conditions.
  • The inventory value may not be adjusted for any changes in value due to damage, obsolescence, or other such factors.
  • The value of inventory may not reflect the true economic value of the goods due to the difficulty in accurately estimating the value of certain goods.

Other approaches related to Inventory value

Inventory value can be assessed using many approaches. The following are some of the most commonly used approaches:

  • Cost Approach: This approach calculates the inventory value by totaling the cost of acquisition of individual items. This cost includes the total amount paid for the item, including tax and transportation, as well as the cost of any associated labor or services.
  • Market Approach: This approach calculates the value of inventories by determining the market price of the items in the inventory. This approach takes into account the current market value of the item, as well as any discounts or other factors that may affect the market price.
  • Profit Margin Approach: This approach calculates the inventory value by subtracting the cost of the items in the inventory from the expected profits from the sale of the items. This approach takes into account the expected profit margin, as well as any discounts or other factors that may affect the profit margin.
  • Replacement Cost Approach: This approach calculates the value of the inventory by estimating the cost of replacing the items in the inventory with new items of the same quality and quantity. This approach takes into account the cost of replacing any damaged or obsolete items, as well as any discounts or other factors that may affect the replacement cost.

In summary, inventory value can be assessed using several approaches, including the cost, market, profit margin, and replacement cost approaches. Each approach takes into account different factors, such as the cost of acquisition, current market value, expected profits, and replacement cost, in order to calculate the value of the inventory.

Footnotes

  1. ↑ P. R. Delaney, O. R. Whittington, 2010, page 187
  2. ↑ S. M. Bragg, 2005, page 35
  3. ↑ S. M. Bragg, 2005, page 85
  4. ↑ S. M. Bragg, 2005, pages 85, 86
  5. ↑ M. A. S. García, R. T. M. Salgado, V. M. R. Carbajal, 2013


Inventory value — recommended articles
Weighted average method — Closing stock — Absorbed costs — Stock register — Operating cycle — LIFO Reserve — Stock turn — Segment margin — Inventory accounting

References

Author: Monika Mendak

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