When we say inventory valuation, we are talking about an accounting technique. To be precise, it is a method to assess the value of unsold stock in time of financial statement preparation. It is usually done at the end of every financial year. Learn more about it in this blog post. And let us also see what good it can do for your business.
Importance of Inventory Valuation
One of a business’s assets is stock in the inventory, and in order to report it on the balance sheet, it has to have a financial value. Inventory valuation helps determine that, and in doing so, it will help you make a plan on your purchases through determining your inventory turnover ratio.
To understand it further, you may be thinking you don’t need inventory valuation to find out the total value of your unsold goods, but no. Why? Let’s say the prices of those stocks changed every month. How would you determine which one costs this and that? You need an inventory valuation method to determine that. Which we will talk about later.
Inventory valuation can also help you apply for a loan for business expansion, keep shareholders happy, attract investors, and save taxes. These benefits are something you will discover depending on the methods that you will choose and will work for your bookkeeping.
Inventory Valuation Methods
To come up with the financial value of your unsold stocks, there are three inventory valuation methods that you can use. These are FIFO (First In First Out), LIFO (Last In Last Out), and WAC (Weighted Average Cost). I’ll elaborate on each method:
In the first-in, first-out method, you presume that the first item you purchased is the first one to be subtracted from the inventory whenever you make a sale. With this method, you’ll know that the unsold stocks are those that you recently bought. And through your purchase records, you know how much they cost so you can easily determine their financial value.
In the last-in, first-out method, you presume that the last item you purchased is the first one to be subtracted from your inventory whenever you make a sale. With this method, you’ll know that the unsold stocks are those that you bought on a later date. With this in mind, I know you can probably imagine that FIFO and LIFO will have different outcome. And that’s because of changes in stock costs every now and then (if any) throughout the financial year.
In the weighted average cost method, to come up with the financial value of unsold stocks, you only need to use the average cost of the goods. This method is usually used when there is no change in the quantity and rate of the purchased stocks all through the financial year.
If you are asking which method is best to use, that actually depends on your financial goals and market condition. You can change your method if you like but don’t do it often as it may complicate your bookkeeping.
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